MICHAEL SALTER March 10 1986


MICHAEL SALTER March 10 1986



This week Finance Minister Michael Wilson, Prime Minister Brian Mulroney and other high-level Tories will fan out across Canada in a political exercise known as selling the budget. The Conservatives will try to convince Canadian taxpayers that large tax increases are a necessary—and fair—way to reduce the crippling federal deficit. But in an unusual action that indicates just how much importance Wilson attaches to deficit reduction, the Tories are also sending top politicians and bureaucrats to meet with members of the international financial community in New York, Washington and London.

Their objective: to try to restore confidence in the government’s actions, the dollar and, ultimately, the Canadian economy. As one Conservative insider said, “They are going to say, ‘Hey, look at what’s going on in Canada; we are on track, we have a plan and the deficit is under control.’ ” But as the government completed last-minute details of the hard-sell agenda, by late last week there was already growing skepticism over whether Wilson’s budget would achieve its twin aims of reducing the deficit and restoring confidence.

Stimulus: As economic and tax experts studied the budget papers, they pointed out that Wilson had based his deficit-reduction targets on some uncertain economic assumptions. And other observers said that implementing Wilson’s austerity program will test the will of the image-conscious Mulroney government. For his part, Wilson clearly indicated that he intended to reduce the deficit still further in the coming months. Last week he singled out reformation of the corporate and federal sales tax systems as a way of raising more government revenues. He also indicated that further cuts to government spending might come from social programs.

Wilson’s strategy is fundamentally different from that of his Liberal pre-

decessors, because economic growth was not one of the direct objectives of his budget. Roger Hamel, president of the Canadian Chamber of Commerce, noted that the budget contained “very little economic stimulus” because the

economy was strong and would continue to grow without government intervention. And a high-ranking bureaucrat said that finance department officials “were told to draft a budget with the object of deficit reduction— their job was to find the right policies to achieve that reduction.”

Recovery: Indeed, the Conservatives are counting on business to take the lead in spurring economic growth. They are predicting that the current strong growth in business spending on plants and equipment will continue. The three-year-old recovery is now being led by business investment rather than

consumer spending as it had been in the initial stages, said Sherry Atkinson, chief economist with Toronto-based Burns Fry Ltd. In 1985 business investment rose by five per cent after inflation to $19.5 billion—up from a low of $18.1 billion in 1983.

Business investment has not yet returned to its previous level—the high so far in the current decade was $22.9 billion in 1981. But the budget’s elimination or reduction of tax loopholes such as the investment tax credit and inventory allowances will have “only a small negative effect on business spending,” said Thomas Wilson, a tax expert with the Insitute for Policy Analysis in Toronto.

Control: Still, whether

Wilson achieves his goal of reducing the deficit to $29.5 billion by next year depends on the accuracy of several key economic predictions. First, the finance department is counting on the fact that the economy will grow by 3.7 per cent after inflation in 1986, down from a 4.5-percent growth rate in 1985. Despite a net increase of $160 million in personal income taxes this year —coupled with $940 million in federal sales and excise tax hikes— finance officials and many business leaders estimated that consumers would keep spending at their current rate because they might decide not to save as much as they usually did. John Bulloch, president of the Toronto-based Canadian Federation of Independent Business, for one, pointed out that Canadians were now saving 12.5 per cent of their total after-tax income, one of the world’s highest overall savings rates.

Wilson is also assuming that, with the deficit under control, within several months the dollar will stabilize on international markets. That would permit the Bank of Canada to reduce interest rates—the prime lending rate stood at 13 per cent last week—by about two points this year. In turn, lower rates would encourage job-creating business

investment. But for each percentage point that rates stay above the government’s estimate this year, about $1 billion would be added to the deficit, said Atkinson.

As well, the government was predicting that the price of oil will average $22.50 (U.S.) a barrel over the remainder of the year—nearly $7 higher than current levels. Late last week Wilson acknowledged that his oil price forecast was already out of date and that the government would lose tax revenue because of falling prices. But he said that those revenues would be regained because lower oil prices would lead to an upsurge in manufacturing and exports to the United States —activity which generates taxes.

Struggled: But Jack Carr, a professor of economics at the University of Toronto, said that overall the fall in oil prices will hurt the economy. And Atkinson described Wilson’s economic assumptions as “overly optimistic.”

She said that this year’s deficit target would not be met unless government spending is cut again or unless the Tories pass an excise tax that would prop up Cana-

da’s oil price. Said Atkinson: “Without such efforts, the Canadian dollar will resume its decline.”

Still, finance department officials struggled for months to come up with the right balance of spending cuts and tax increases. An increase in gas taxes—in the face of declining prices in the United States—was rejected as unwise. Department experts considered eliminating the $1,000 interest income deduction, but they discovered that many of those who claimed it were elderly, poor—or both. “It’s the low-income person’s tax deduction,” an official said.

Finally, the government decided to raise taxes through a three-per-cent income surtax because that method spread the burden over a wide range of the population—instead of singling out one group. And there are already indications that the Tories may be able to sell the tax increases as a necessary part of reducing the deficit. Said Pamela Buick, 28, a clerk with a Vancouver brokerage firm earning about $23,000 annually: “They have to reduce

think the budget was bad at all.” For his part, James Mann, a married 30 year-old farmer in Hodgeville, Sask., said that he thought the budget “more or less distributed the tax burden fairly.”

Contentious: Having imposed most tax increases on the middle class, many political experts said that as the Tories move closer to a general election Wilson would still emphasize cutting the deficit—but through tax reform and by reducing spending on government programs. One of the indications of how that reform will take place is evident in the budget’s changes in the corporate tax system. An extra $765 million is being raised from corporations this year and next by closing loopholes, officially called tax preferences. That will broaden the tax base even though the corporate tax rate will decline.

Wilson says that he also intends to reform the federal sales tax system. Currently the sales tax, now at 12 per cent, applies to only 30 per cent of the goods produced in Canada. That tax may be replaced with a business transfer tax that would be imposed on all goods and services.

A far more politically contentious action will be Wilson’s renewed attack on social programs, including unemployment insurance, which currently accounts for 61 per cent of Ottawa’s program costs. His strategy, he says, is to “maintain universal access” to social programs while directing more money to the needy by taxing back those benefits from high-income Canadians. In selling this approach, Wilson will stress fairness and the importance of meeting the needs of the poor.

Decline: Many business groups—including the influential Business Council on National Issues—applauded Wilson’s moves to cut the deficit as a step in the right direction. But he appears to have angered many Canadians by proposing tax increases that were more than twice as large as expenditure cuts. Ottawa will raise $1.48 billion through tax increases in the fiscal year ending March 31, 1987, compared to $670 million in cutbacks.

Still, Wilson pointed out that spending on all programs (exclusive of the interest on the debt) will decline to $86.6 billion this year, the first absolute decline in 20 years. Said Michael McCracken, president of Ottawa-based Informetrica Ltd.: “Anyone who says there is no restraint on the government side is not looking at the numbers.” Indeed, as Michael Wilson goes on the road this week, he will be trying to convince Canadians that when it comes to the deficit less is more.

MICHAEL SALTER with THERESA TEDESCO in Toronto, MARY JANIGAN in Ottawa and correspondents’ reports