Dear Prime Minister,
For the first time in the history of the Business Council on National Issues (BCNI), our Board of Directors has been able to hold a meeting and discuss fiscal policy without the overhanging shadow of a federal deficit. We have written to you and your predecessors many times, always arguing that a balanced budget could be achieved in relatively few years. But the elimination of the deficit in this fiscal year is a testament to the vision, courage and determination of you and your government. As we noted in our immediate response to the recent budget tabled by Finance Minister Paul Martin — bravo!
Like your government, the BCNI has now turned its attention to the post-deficit world, and we would like to share with you, Mr. Martin and your cabinet colleagues our thoughts on the challenges and opportunities that lie before us.
RESTORING HOPE AND CONFIDENCE
As this decade began, most Canadians were convinced that their lives were governed by inexorable realities: every year, prices would go up; every year, taxes would go up; and every year, their real take-home pay would go down. Today, thanks to well-coordinated monetary and fiscal policy, the first of those convictions has been dispelled. Inflation is negligible, and as the economics of technology spread through virtually every industry, Canadians increasingly expect higher quality goods for lower prices. A dollar that buys more rather than less is a sign that quality of life is on the rise.
Your government’s achievement in balancing the budget opens the door to dispelling the other two convictions as well. As long as governments ran deficits, Canadians knew in their hearts that every year had to bring higher taxes just to maintain the same level of services, as growing debt charges ate up more of every tax dollar. And while cuts in federal spending have been significant, the rapid progress toward fiscal balance has been due primarily to growth in tax revenues.
The achievement of balance and the potential for substantial surpluses in the years ahead give the government a unique opportunity to correct the damage inflicted by years of deficits and to restore hope in the future. We believe that a determined assault on the level of the national debt is required to ensure a steady reduction in the amount of tax revenue required for debt service. This is turn will allow Canadians to enter the new millennium convinced that every year, they can expect their total tax burden to fall rather than to rise.
Consider this potential transition in a broader context. Canadians at the beginning of this decade felt immersed in gloom, beset by shrinking opportunities, eroding social programs, rising taxes and a fraying federation. Every year, their jobs and lives seemed to grow less secure, and it seemed inevitable that their children would be even worse off.
The years of restructuring have taken their toll, but Canada has emerged as an economic powerhouse, competitive with the best in the world, achieving record exports year after year. The hard work and sacrifices made by all Canadians are paying off. The pace of job creation is rising, the unemployment rate is falling and Canadians are feeling increasingly confident and secure in their personal lives.
At the same time, they still feel very uneasy about their children’s prospects. Youth unemployment remains high, especially for young people who have not had the opportunity or desire to pursue post-secondary education. Those with jobs have seen their relative earnings fall as rising public debt levels promise a future blighted by growing tax bills.
A strategy of aggressively reducing Canada’s public debt load is highly desirable. It will usher in steadily decreasing tax levels for today’s workers. It is the key that can unlock the door to a new era of opportunity for the next generation.
By wrestling inflation to the ground, by eliminating most government deficits and by surmounting the challenges of free trade and global competition, we have passed from pessimism to short-term confidence. Now we must take the steps that will allow all Canadians to be sure in our hearts that our own quality of life will improve year by year, and that our children will inherit an even better world than we enjoy today.
FROM DEFICIT TO DEBT
To meet this challenge, it is not enough simply to balance the budget. As a matter of inter-generational equity alone, we must avoid handing to our children the cumulative burden of this generation’s deficits. Over the longer term, we must be ready as a country to meet the new challenges emerging from changing demographics and more demanding requirements in health care. And we must recognize that huge interest payments on public debt represent a continuing constraint on the potential for government action. Even at today’s very low interest rates, the federal government will spend $41.5 billion this fiscal year on debt service charges alone. This is almost equal to the total amount the government spends on transfers to the elderly plus all cash transfers to the provinces, including those for health, education, social services and equalization. Twenty years ago, debt service ate up only one dollar out of every eight the government spent. Now the ratio is more than one in four.
This huge rise in debt service charges within the global budget clearly squeezes out other spending priorities and pushes tax rates higher. We are at a point now where interest rates are unlikely to move lower, and indeed the budget projects a significant rise in rates. The only way for the government to regain its lost fiscal flexibility is to begin paying down the national debt and reducing as quickly as possible the amount of money being spent on debt service.
We believe that your government pursued an eminently sensible approach to deficit reduction by establishing concrete and achievable short-term targets. More than anything else, the consistent achievement and overachievement of those targets built the credibility essential to gaining the support of financial markets, credibility that in turn helped bring interest rates down even faster.
It is essential to maintain the momentum of this approach by extending short-term targets to debt reduction. This could be done either in terms of actual dollar reduction or, in the context of a growing economy, as a percentage of Gross Domestic Product. The Standing Committee on Finance of the House of Commons has suggested a target range of between 50 percent and 60 percent by the end of the government’s mandate. We believe, especially given the recent recalculation of GDP, that the 50 percent target is achievable and would represent another credible and significant milestone along the road to continued improvements in the quality of life of all Canadians.
As with a home mortgage, higher payments in the early years have the greatest impact. We urge you, therefore, to use the final years of this decade to consolidate the government’s fiscal gains. In addition to the medium-term target of 50 percent of GDP, we recommend that your government set a short-term goal of reducing the debt to 60 percent of GDP over the next two years. The economic and fiscal forecasts in the 1998 budget are conservative and substantial surpluses are likely. The government should commit to debt reduction as much of these surpluses as necessary to reach the 60 percent target.
The government should make it clear that this highly disciplined approach in the short term is the first step toward the implementation of significant and growing tax cuts through the early years of the next decade.
THE NEED FOR SUSTAINABLE TAX CUTS
The build-up of debt by both federal and provincial governments has driven Canada’s tax burden to a record high. Total government revenues are about 45 percent of GDP. Household tax payments as a percentage of disposable income are at record levels in Canada. By this measure, the gap between Canada and the United States is also at its highest level ever. Clearly, taxes must come down, and the objective of debt reduction is to ensure that when they do, Canadians can count on taxes remaining low through subsequent ups and downs of the economic cycle.
We understand and respect your government’s desire to direct initial tax relief at those Canadians most in need. The focus on financial support for low-income families with children, whether the parents are working or not, is an essential element in fostering true equality of opportunity for the next generation.
But we must emphasize that sustainable economic growth will require very significant tax cuts at all income levels. As the heads of enterprises actively engaged in competition with foreign companies both in Canada and abroad, we are facing difficulties in recruiting and retaining highly skilled employees in many fields. Canadian society does offer benefits that offset to some extent our higher tax levels. But the people we are losing are the ones best able to contribute the creativity, innovation and entrepreneurial energy that Canada needs most. In a global knowledge-based economy, human resources rather than natural resources hold the key to our economic independence. In the struggle to attract, develop and retain this human capital, both high total tax rates and high marginal rates have a powerful adverse impact.
We also would warn that the trend toward means-tested benefits and tax relief is making marginal tax rates a critical issue even for low and middle income earners. Excessive marginal rates at any level of income effectively tell taxpayers that working harder or investing in the future does not pay. They encourage passive dependence on governments rather than initiative and enterprise and foster dishonesty and the growth of the underground economy.
While personal income taxes may provide the most urgent examples of the need to reduce tax rates, other taxes also have a damaging effect on our company. In particular, we would point to payroll taxes, which have a direct impact on the ability of companies to add jobs as well as on the after-tax incomes of employees. Your government has enacted long-overdue reforms to the Canada Pension Plan, but these reforms will require steadily increasing premiums. We would repeat our suggestion that Employment Insurance premiums — which now vastly exceed the cost of EI benefits — should be reduced to offset this necessary burden.
We could catalogue many other forms of taxation that diminish economic growth and reduce the quality of life Canadians could otherwise enjoy, but we remain mindful of the need to bring down tax rates in a sustainable way. An early focus on debt reduction will pave the way for significant and growing personal income tax cuts and then for progressive reduction of EI premiums. Ultimately, confidence in the future course of tax levels is far more important than the progress made in any given year. As with the battle against the deficit, steady and repeated successes will build momentum and reinforce public belief in the government’s ability to deliver more significant relief over time.
RISKS TO THE OUTLOOK
The BCNI’s focus on debt reduction is driven to a great extent by the serious risks posed by the current level of debt. Canada’s fiscal progress and growing competitiveness have increased international confidence in our country and our currency, and the Department of Finance has taken steps to minimize short-term risks by extending the average maturity of this debt. The fact remains that the commitment to budget balance in the years ahead could be derailed by any prolonged upturn in interest rates.
The most important lesson of the continuing crisis in many Asian economies must not be ignored. The combination of currency devaluations, rising interest rates, slowing growth, falling investment and loss of confidence has been devastating to the quality of life of hundreds of millions of people — all living in a place that was seen less than a year ago as the most dynamic region in the world. However positive Canada’s current outlook may be, the Asian crisis has shown that even a fast-growing economy can be devastated in short order if international financial markets lose confidence for any reason.
Some of the risks to confidence in Canada’s currency and economy are beyond our control. We already have seen weakness in the Canadian dollar — and an increase in short-term interest rates — as a result of the Asian crisis and its impact on commodity prices and export volumes. Continuing uncertainty in the region could intensify this impact.
On the other hand, the very strength of the United States economy and its tight labour markets poses the risk of an increase in inflation and interest rates there. This could have a double impact on Canada, both by slowing growth in the United States and exports from Canada, and by forcing interest rates to rise here even while inflationary pressures in our country remain minimal.
Finally, of course, there are the risks of self-inflicted wounds. The BCNI has been encouraged by the broad acceptance across all regions of the principles laid out in the Calgary Declaration. Even so, a provincial election in Quebec is likely within a year, and a victory by Premier Lucien Bouchard and his party could unleash yet another referendum on secession. Both the election and referendum processes have in the past attracted international attention to the risks of a break-up of the country and led to sharp upward movements in interest rates. The potential damage of a vote in favour of secession would, of course, be much greater.
We are still confident that Canada will remain one of the world’s success stories, but we must not ignore the need for continued prudence in fiscal policy. Other longer-term risks, such as the economic implications of Canada’s commitments under the Kyoto protocol on global climate change, also must be kept in mind. A focus on debt reduction both maximizes the long-term benefits to the standard of living of all Canadians and reduces the shorter-term risks we face as a country.
KEEPING GOVERNMENT RELEVANT
While arguing consistently for smaller, more efficient governments, the BCNI has never suggested that Canada would be better off without them. The battle against the deficit has led to leaner and more focused federal programs and structures. Success in that battle, however, has fuelled calls from some quarters for a reversal of past funding cuts and sharp increases in spending now that the immediate fiscal crisis is over.
The government should as always consider Canada’s evolving needs and take action where appropriate. What worries us is the threat of a return to “the good old days” where programs once established became untouchable and funding requirements only went up. In our view, where government has good cause to act, it should invest appropriate funds to meet efficiently and effectively the needs of Canadians — but such investments should not necessarily represent additions to total spending.
Just as new needs emerge in an evolving society, so old needs become less compelling, and spending in these areas should be reduced. Governments, like companies, must adapt to meet the needs of their constituents or customers. As a general principle, therefore, we would argue that the policy of the deficit-fighting years — that funding for new programs had to be found within existing resources — should be continued.
Taxpayers should be asked to fund only as much government as is necessary to meet the country’s needs. If governments are to deliver value for the taxpayer’s dollar, they must engage continuously in a review of what they do now as well as considering new needs as they emerge. The search for leaner and more effective government should not be abandoned just because we have reached budget balance.
This year’s budget chose to focus on the need to expand equality of opportunity for young people and improve access to post-secondary education through tax changes and the Millennium Scholarships. We agree that investment in the knowledge and skills of all Canadians plays a vital role in the competitiveness of our companies and our economy. We understand the return on such investments, and that is why BCNI member companies account for the majority of private-sector investment in training, allocating an average of $1,800 annually per employee, more than four percent of payroll, to human resource development. We acknowledge that access to education is crucial to the future well-being of young people and that high levels of student debt can inhibit their access. But we would suggest that a high level of national debt and large student debts are equally threatening to their future prosperity.
As matters stand, your government has pledged to spend half of the so-called fiscal dividend on new spending and to split the rest between tax cuts (which can be another form of program spending) and debt reduction. We disagree with this formula on two counts.
First, as we have indicated already, budget balance is no excuse to renew bad habits. In our view, total spending (program spending plus debt service charges) should rise no faster than the rate of inflation. This approach requires continuing efficiencies in existing programs to accommodate population growth, but reinforces the additional flexibility governments would gain from accelerated debt reduction. Second, because the split between tax cuts and debt reduction is left undefined, the government’s 50/50 formula effectively provides no commitment at all to paying down debt. Our worries about this weakness were compounded by the decision to spend this year’s contingency fund rather than direct it to debt reduction.
Continued discipline in the post-deficit era is far more than an accounting exercise. Rather, it represents the most effective strategy for enhancing the relevance of the federal government within the economic and social union. Repeated deficit financing was the fundamental source of the erosion of federal power. As rising debt service costs ate into program budgets, the federal ability to influence through spending was diminished. Given the huge national debt and the evolution of the federation, that influence cannot be restored by a return to massive spending.
We would suggest that restraint rather than profligacy is in fact the key to renewed federal authority. The federal achievement in balancing the budget has paid visible dividends to Canadians already in the form of lower interest rates, more robust economic growth and a faster pace of job creation. As we look forward, we see the federal government playing a vital role within a strengthened federation, not by imposing its will through its spending power, but rather by achieving greater influence through inspiration and leadership. The most important job of the federal government is to make sure that Canada continues to work — and is seen to work– in the best interests of all its citizens.
A BALANCE FOR THE MILLENNIUM
Prime Minister, the members of the BCNI are immensely proud of the progress Canada has made in recent years under the leadership of your government. Economic growth is strong and job creation is accelerating. The World Economic Forum now ranks us fourth in the world in competitiveness, up from 16th place just a few years ago, and according to the United Nations, Canada also has had the highest quality of life for the past four years in a row. It is a good news story that we delight in telling to audiences around the globe.
The struggle against the deficit was not easy, but your government persevered and all Canadians are better off. While we should celebrate our success, it is time to reinforce our determination, not to relax. Our duty now is to turn flickering hope into blazing confidence and build a brighter future, not just for today’s citizens but for the generations to follow.
Early this decade, BCNI members pledged to help make Canada the best-performing economy in the G-7 by the year 2000. The country is now at or close to that goal — and our progress is a testament to what can be achieved when the private and public sectors work together for a common purpose. We look forward to continuing to work with you and your government in the days ahead as we take our good news story and make it even better.
On behalf of the Policy Committee
Business Council on National Issues
A. L. Flood
President and Chief Executive