COVER

THE BUDGET: ‘A TAX TIDAL WAVE’

HARSH MEASURES—AND A BIG DEFICIT

D’ARCY JENISH May 8 1989
COVER

THE BUDGET: ‘A TAX TIDAL WAVE’

HARSH MEASURES—AND A BIG DEFICIT

D’ARCY JENISH May 8 1989

THE BUDGET: ‘A TAX TIDAL WAVE’

COVER

HARSH MEASURES—AND A BIG DEFICIT

With a little luck, Miller Ayre calculates, Finance Minister Michael Wilson’s April 27 budget might actually be good for Canadian clothing retailers. Ayre, a St. John’s, Nfld., businessman, runs three women’s clothing chains—J. Michael’s, Kristy Allan Fashions and Holly’s Fashion Shops—with 80 stores across the country. His reasoning: faced with higher taxes and an uncertain economy, consumers will likely spend less on cars, furniture and appliances and more on clothing. But apart from that glimmer of optimism, Ayre was disappointed in a budget that will add $10.6 billion to a wide range of taxes paid by Canadians and cut federal spending by $3.6 billion over the next two years—just to hold its annual deficit in the current range of $29 billion to $30 billion. Across the country, businessmen, labor leaders and social policy activists expressed similar sentiments. Said John Bulloch, presi-

dent of the 82,000-member Toronto-based Canadian Federation of Independent Business: “I call it a tax tidal wave that is going to wash out a lot of consumer spending and business activity.”

Despite the chorus of complaints following last week’s budget, most observers conceded that Wilson had at least spread the burden of deficit cutting to all quarters of society. He cancelled a planned child care program and cut back spending on foreign aid, passenger rail service, payments to the provinces and defence (page 19). The government will also tax back old-age security and family allowance benefits paid to Canadians with net incomes—total annual income minus pension contributions and certain other deductions—exceeding $50,000 (page 18). Large corporations and wealthy individuals will be hit with new taxes. The existing surtax on all personal income is going up, and Wilson raised taxes on cigarettes,

alcohol and gasoline. He also increased the federal sales tax on selected manufactured goods and proposed that Ottawa end its contributions to the unemployment insurance program, leaving employers and employees to make up the federal contribution. At the same time, he set the rate for his controversial goods and services tax, to be introduced at the beginning of 1991, at nine per cent. Said Shirley Carr, president of the Canadian Labor Congress: “It’s an economic mugging.”

But even with higher taxes, new taxes and a deficit stuck in the neighborhood of $30 billion in total spending of $142.9 billion this fiscal year, Wilson predicted that the Canadian economy would remain healthy during the next two years. He foresaw a three-per-cent increase in the real gross domestic product—the total net value of goods and services produced in the country after discounting inflation—this year and a further 1.7-per-cent increase next year. But both figures were down from a robust 4.5 per cent in 1988, and Wilson forecast that unemployment would jump to 8.2 per cent this year from 7.7 per cent in 1988 and that inflation would creep up to 4.8 per cent from 4.1 per cent.

Risky: Some business leaders and economists predicted that the budget itself would be inflationary and would force the Bank of Canada to maintain the tight money policy that pushed its trend-setting interest rate to 12.62 per cent last week. Roger Hamel, president of

the Canadian Chamber of Commerce, said that most of the new or increased taxes on the business sector will be passed on to consumers in the form of higher prices. At the same time, he said, government borrowing to finance the deficit will put upward pressure on interest rates.

Although politically risky, deeper spending cuts would have been less damaging to the economy than tax increases, Hamel said. But rather than reduce expenditures, the Tories will allow overall government spending to grow, though at a slower rate than that they project for the economy. Over the next four years, spending will rise at an average annual rate of 3.9 per cent, compared with five per cent annually during the past four years and 15 per cent annually in the last four years THE of Liberal rule. Yet business leaders were not impressed.

Said Bulloch: “This is a tax, tax,tax, spend, spend, spend government.”

Submarines: Still, there were also direct program cuts that were bound to be both painful and controversial. Those cuts eliminate $3.6 billion in previously planned spending over the next two years. The government will close seven military bases and reduce the size of another seven. It also scrapped the politically unpopular proposal to buy a fleet of nuclear submarines at an estimated cost of $8 billion. And it chopped $370 million from commitments to child care made in December,

1987. Foreign aid, currently running at about $2.8 billion annually, will be cut by $360 million in each of the next two years. Starting next year, the provinces will lose $200 million in transfer payments for health and postsecondary education. Payments to Crown corporations are also being cut. Via Rail will be hit hardest, losing $125 million in subsidies, while the Canadian Broadcasting Corp. ’s $915-million annual subsidy will be cut by $140 million over the next four years. The government is also reducing its $220-million postal subsidy for magazines, books and newspapers by $45 million over the next two years (page 58).

Still, the Tories relied primarily on higher taxes to solve the country’s deficit and debt problems. And the budget documents showed that individuals, rather than the business community, could bear the brunt of the tax load. By 1991, Ottawa will collect $55 billion in personal income tax, compared with $45.1 billion in 1987. During that same period, total corporate income tax will have risen to $14.6 billion from

$10.8 billion. What is more, said Valerie Sims, acting director of the Canadian Council on Social Development, “lowand middle-income households will bear the brunt of the government’s deficit-cutting exercise.”

Surtax: In order to tighten the system, the government has devised a new tax on all large corporations. That new tax will be levied against a company’s value rather than its profits. Under a provision that will apply to at least 3,600 companies, Ottawa will impose a tax at a rate of 0.175 per cent on capital—the value of a company’s shares, its retained earnings, cash reserves and loans—in excess of $10 million. Combined with an existing surtax, the new large-corporation tax is expected to raise an

THE BUDGET AND THE DEFICIT BILLIONS OF DOLLARS BY FISCAL YEARS

extra $1.4 billion in federal revenues over the next two years.

Some economists and accountants said that they feared the federal government will be tempted to raise the new tax in subsequent years, and they warned that it could discourage investment in Canada. Douglas Bradley, a tax partner in the Toronto-based accounting firm Coopers & Lybrand, said that the tax applied only to capital employed in Canada. Domestic companies might try to avoid the tax by investing outside the country. Said Bradley: “It is a disincentive to investment.”

Most individuals, as well, will be paying higher taxes. The current federal surtax, which is equivalent to three per cent of an individual’s federal income tax, will be raised to

five per cent on July 1. In addition, earners with net annual incomes in excess of $70,000 will pay another three-per-cent surtax, or a total of eight per cent of their basic federal tax. Those measures should net the government an additional $1.9 billion over the next two years.

Canadians will also pay $3 billion in higher tobacco, alcohol and gasoline taxes over the next two years. Increases to the federal sales taxes on manufactured goods and telecommunications will bring the government $3.2 billion, most of which will be paid by consumers through higher prices. Said Antony Clarke, social affairs director of the Ottawa-based Canadian Conference of Catholic Bishops: “The largest share of deficit-cutting measures has fallen on the backs of working people.”

But even with all the new and higher taxes, the government will make no progress in reducing the annual budget deficit and the growth of the accumulated national debt. The deficit is scheduled to reach $30.5 billion in the current fiscal year, up from $28.9 billion in the year that ended March 31. According to Wilson’s projections, it will then decline only marginally to $28 billion next year. The primary problem is high interest rates, which will increase the cost of servicing the debt by $13.2 billion over the next two years from $33 billion this year, assuming that interest rates peak at 12 per cent during 1989 and decline to 10.1 per cent in 1990. Still, Wilson predicted that within four years the deficit will drop dramatically to $15 billion due to spending restraints, tax increases and a stronger economy.

Tough: But such optimistic forecasts did little to ease the concerns of Canadians who expected that a tough budget would have an immediate impact on the deficit. Said Newfoundland retailer Ayre: “It is about what we expected in terms of harshness, but the government didn’t get the deficit below $30 billion. It is all pain and no gain.” Others said they feared that by 1992 the government, facing another election, will abandon its commitment to spending restraint. But some observers contended that the government’s reliance on tax increases, rather than spending cuts, reflected political reality. Bulloch said that cutting a $20-million program can trigger a fullblown protest campaign with petitions, demonstrations and denunciations of the government. But, he said, a $l-billion tax increase seldom brings out the demonstrators.

D’ARCY JENISH in Ottawa