Confronting global economic uncertainty: a Canadian strategy

Dear Prime Minister,

When the Board of Directors of the Business Council on National Issues (BCNI) last wrote to you in March of this year, it was to convey our congratulations to you and the Minister of Finance on the vision, courage and determination shown by your government in achieving budget balance. At the same time, we urged a prudent approach to fiscal management and the adoption of a dynamic strategy for moving forward with further economic reforms. We suggested that celebration, however well deserved, was no excuse for relaxation in our continuing quest to build a better future for Canadians.

Events since, both within and beyond Canada’s borders, have amply justified our recommendations for prudence and for moving boldly forward with an agenda for economic reform. We are pleased once again to share our thoughts with you as you, the Minister of Finance and your colleagues in cabinet and caucus begin to make the choices that will be reflected in the 1999 budget and beyond.

We believe that the following actions are necessary to ensure continued prosperity for Canadians through and beyond the current period of global uncertainty.

• Canada’s high level of public debt continues to leave the country extremely vulnerable. This reinforces the need for the federal government to pay down its debt by more than the allocation of unused contingency funds as laid out in the last budget.
• Canada is losing highly skilled workers as well as job and investment opportunities as a result of excessive and uncompetitive rates of personal taxation. Rising taxes also have left many Canadians with lower real incomes. The federal government must make a commitment now to begin significant cuts in personal income tax rates in the next budget and to continue cutting taxes across the board in years to come.
• In the current economic environment, there is no room at all for new discretionary spending in the short term. The government instead should make a firm commitment of all surpluses to the more vital priorities of debt and tax reduction.

THE CHALLENGES TO CONFIDENCE

What began as regional turmoil in Asia has spread, and is now having a very significant impact on the global economy. It is clear that global economic growth is slowing, possibly to as little as two percent in 1998, half the rate recorded just a year earlier. Currencies everywhere are under attack as capital shifts toward perceived safe havens. Even in the United States, the uncertainty about growth and profits has led to a sharp correction in equity markets.

As a trading nation with exports as a share of GDP twice the G-7 average, Canada of course has been affected. Commodity prices have dropped, and our terms of trade and current account balance have deteriorated. Our currency, recovering somewhat after falling to historic lows against the American dollar, remains susceptible to any further round of contagion. Real economic growth for 1998 may be reduced to less than three percent, and could fall well below this level in 1999.

That said, it is important to maintain a sense of perspective and to note that Canada is in far better shape to withstand today’s global challenges than it was even five years ago. The federal and some provincial governments are in balance or surplus. Inflation remains very low. Productivity growth has begun to improve. Our public debt is still too high, but is now less exposed to short-term fluctuations in interest rates and currency markets. We face trying circumstances, but we are well positioned to endure and then overcome the difficulties that surround us if we move forward convincingly with the right policies.

MANAGING GLOBAL AND DOMESTIC RISKS

We are in the midst of a volatile and dangerous environment. The international economic situation is serious and is likely to worsen. This could lead to an even greater impact on commodity prices and on the Canadian dollar than we have seen to date. In addition, should global developments lead to a continuing downturn in equity markets and significantly lower growth in the United States, our export-driven economy will suffer much more extensively. While Canadian growth is now broadly based across all sectors, we also are seeing an impact on both business investment and consumer confidence that could become more serious.

Within our borders, the time for an election in Quebec — and possibly for another referendum on secession — draws nearer. The possibility of secession as always threatens our future prosperity. Any evidence of renewed support for separation could be especially damaging in today’s turbulent currency markets. The recent decision of the Supreme Court of Canada, however, has injected into the debate about Canada’s future a vital element of reason that we hope will continue to moderate the rhetoric and encourage continued dialogue and negotiations within the context of the federation.

Both global and domestic factors may influence currency markets in the months ahead, and there is a limit to what Canada can do to prevent sharp fluctuations in the Canadian dollar in the short term. The Bank of Canada must clearly, at times, use its power and resources to ensure that confidence in the future value of the dollar is maintained, because that is how low interest rates are sustained. We are, however, extremely conscious of the need to avoid choking off growth during a period in which our output gap has yet to close, growth is slowing and inflation is negligible.

Both governments and business must do their part to assist the Bank of Canada in its efforts to rebuild confidence in the Canadian dollar and in the future value of Canadian assets. The members of the BCNI certainly intend to continue their efforts to help international investors understand the extent of the progress Canada has made in recent years.

The most important role for Canadian governments is to reinforce that good news with fiscal choices that clearly will lead to an even more competitive economy and more robust economic growth. Such policies cannot guarantee an immediate rebound in the value of our currency, but they are necessary conditions if Canadians are to enjoy a rising standard of living in the years ahead.

THE NEED TO LIMIT SPENDING

Using very prudent assumptions, the Minister of Finance has projected two successive years of balanced budgets. Most economists expect surpluses despite the signs of economic slowdown. As a result, a multitude of voices are now being heard pleading for a share of the presumed bounty to be distributed as a reward for accepting years of strict fiscal discipline.

Significant new spending commitments would send precisely the wrong signal to Canadians and to international markets about your government’s commitment to continued fiscal responsibility. And within the modest surpluses that should be available, there are more urgent priorities. In the current environment of uncertainty, increased attention to debt reduction is mandatory, and commitment to significant tax cuts is essential to preserve Canada’s competitiveness and ensure its prosperity. In our view, there is no room at all for new discretionary spending initiatives at this time.

This means that calls by the Premiers for restoration of health and social transfer payments to provincial governments must be put on hold. Make no mistake. The BCNI strongly supports an efficient, high-quality, publicly funded health care system in Canada. We recognize that cuts to federal transfers left the Premiers with the unpopular and difficult task of making Canada’s health care system work more efficiently. We agree that health care remains the highest priority for increased spending when fiscal circumstances permit. And we believe that when the federal government can afford to increase spending, the money should flow first to provincial governments through transfer payments.

But in our judgment, the uncertain global environment and the need to focus limited fiscal resources on debt and tax reduction requires deferral of any restoration of transfer payments for at least one year. Should the government judge that this or any other proposal for new discretionary spending is necessary, it should cut other expenditures that it deems to have become less critical.

DEBT REDUCTION REMAINS A TOP PRIORITY

On many occasions in the past, we have written about the importance of reducing Canada’s debt, both in absolute terms and as a proportion of our Gross Domestic Product. Canada certainly is on the right track. From a high of some 72 percent of GDP, the government projects a decrease to less than 63 percent by the end of the decade. On a combined federal-provincial basis, Canada’s debt to GDP ratio will drop from 104 percent to 96 percent this fiscal year.

This is significant progress. Within the G-7, our relative debt level will move from second to third worst, ahead of Japan and Italy. But with interest on its debt still draining more than $40 billion a year from federal coffers, the federal government’s fiscal position remains dangerously exposed to the vagaries of the global economy and markets.

This past March, the BCNI suggested a medium-term debt-to-GDP target of 50 percent. Without suggesting a date, Finance Minister Paul Martin has more recently suggested that an eventual target of 40 percent might be more appropriate, and we would support an effort to reduce debt to that level within a reasonable period.

Reaching either of these targets will require a more aggressive commitment to debt reduction than the simple allocation of unused contingency reserves proposed in the last budget. At the very least, all end-of-year surpluses flowing from prudent economic assumptions also should be applied to reduction of federal debt.

Such a commitment would consolidate the gains that have been made over the past four years, increase future fiscal flexibility, and send a clear message to markets about your government’s continued commitment to responsible management of the nation’s finances. This commitment would then provide the foundation for sustainable and steady reductions in Canada’s level of taxation.

A TAX REDUCTION STRATEGY FOR CANADIANS

As we noted in our memorandum to you in March, Canada’s tax burden has become far too high. Every year of deficit financing is a promise of higher taxes to come. In achieving budget balance, your government has promised to stop raising taxes. Now we must begin to undo the damage of the past.

Between 1985 and 1996, real per capita income tax rose four times as fast as per capita income. Canadians at all income levels saw their income tax bills rise in real terms, and all but the lowest income families suffered a significant loss of real after-tax purchasing power. Canada’s personal tax system is now badly out of step with that of our most important international trading partners and competitors, especially that of the United States. Our personal income tax levels are especially onerous, with Canada relying more heavily on personal income tax than any other G-7 country.

Canada’s high taxes do more than take money out of the pockets of individuals. They discourage those out of work from seeking employment. They reduce the incentives for those of modest incomes to improve their productivity and qualify for better jobs. They make savings and investment less attractive and undermine job creation and economic growth. In hampering our competitiveness, they have contributed to the decline in the Canadian dollar. And in so doing, they continue to eat away at the standard of living of all Canadians.

Our high tax rates also threaten our future. They cost the country the substantial investments we make in the education of our best and brightest young people. They drive away the most experienced of the highly skilled Canadians who hold the key to our growth in a global, knowledge-based economy. They make it all but impossible to attract scarce talent from abroad and jeopardize Canada’s future as a home base for vibrant multinational enterprises.

The time has come to reverse the course of tax rates for Canadians. The fiscal discipline of recent years has created an opportunity that must not be missed. Given the uncertainty that surrounds us, the government must take action now to reduce personal income taxes in ways that will raise real after-tax incomes, improve the incentives for work and investment and reinforce economic growth. Early tax cuts also would help to offset the adverse economic impact of the recent rise in interest rates.

Regrettably, Canada cannot yet afford the deep, across-the-board tax cuts that are needed. Our fiscal situation is such that we must proceed toward that goal in incremental steps. Even so, the government can achieve significant results within its current mandate and set the burden of taxation on a permanent downward path.

In order to address the challenge of reducing taxes as quickly as possible within a fiscally responsible framework, the BCNI launched a Tax Reduction Initiative last spring. This initiative has involved extensive discussions among the Council’s member chief executive officers, and we will be sending you our detailed recommendations shortly.

Two points are essential. The first is that we must begin the process of cutting taxes now in ways that address key structural problems in our tax system. The second is that to maximize the impact on both international and domestic confidence of the modest cuts we can afford to make today, your government must commit itself to a credible, multi-year framework for continuing tax reduction.

The use of firm rolling targets was crucial to the success of your efforts to bring the federal budget into balance. Consistency in setting and exceeding targets reinforced confidence and allowed Canadians to reap the benefits of fiscal discipline more rapidly. In seeking to change the course of taxation in Canada, it is even more important for the government to commit itself to an open and consistent plan of action.

Adopting such a course requires both vision and courage, qualities that you and your colleagues have amply demonstrated in the fight against the deficit and that will serve Canadians well in the quest for lower taxes and a higher standard of living. We strongly recommend that this commitment be voiced clearly in the traditional autumn economic statement of the Minister of Finance and that the framework for continuing tax reduction be tabled in the next federal budget.

STABILITY AND GROWTH DEPEND ON CAREFUL CHOICES

As a trading nation, Canada cannot avoid being buffeted by storms of international uncertainty. The country’s finances are far more shipshape than they were just a few years ago, and we are confident of Canada’s ability to ride out whatever gales may yet lie ahead.

Our goal, though, is more than simple survival. We remain proud of the progress Canada has made under the leadership of your government, but much work remains to be done if we want to ensure that Canadians experience a rising standard of living within the global community. Nor can we afford to stand still. Given the challenges we face, inaction will put our achievements to date at significant risk.

Prime Minister, the essence of our advice to you has not changed since we wrote to you six months ago: restraint in public spending, discipline in reducing debt and commitment to sustainable tax cuts. What has changed is a global environment that no longer provides any significant margin for error.

As the next essential step in a sound fiscal strategy, we will be sending you within a few weeks our detailed recommendations for a framework of sustained tax reduction. We look forward to continuing a fruitful discussion on this and other fiscal issues and to working with you and your government to ensure that the right choices are made for all Canadians.

Sincerely,

On behalf of the Board of Directors
Business Council on National Issues

A. L. Flood
Chairman

J. Edward Newall
Honorary Chairman

Peter J. G. Bentley
Vice-Chairman

Jacques Bougie
Vice-Chairman

Jean C. Monty
Vice-Chairman

David P. O’Brien
Vice-Chairman

Thomas d’Aquino
President and Chief Executive