MARTIN’S BIG PLAN
For Finance Minister Paul Martin, it was a disturbing—but perfectly timed—crisis. As his fellow ministers filed into the cabinet room last week for their pivotal meeting on the upcoming federal budget, they were already grimly aware that the Canadian dollar was, once again, sliding on international markets. After lunch, when they called their offices, they learned that the dollar’s plight was headline news—and that interest rates were heading upward. It was enough to quell the few remaining ministers who questioned Martin’s tough package of proposed spending cuts and tax increases. The discussions were calm, almost resigned. The cabinet unanimously endorsed Martin’s package. Unless interest rates increase precipitously over the next few weeks, forcing the finance minister to request further tax hikes, the liberal government came away convinced that it now has the broad outlines of a plan to reach its deficit targets. “There is a shared collectivity around that table now,” a senior liberal told Maclean’s. “There is a real sense that, whether we like it or not, the day of reckoning has fallen on us. We have to get the situation under control.”
The cabinet’s plan constitutes an extraordinary package—if only because governments have traditionally been hesitant to make sweeping spending cuts. The plan is designed to ensure that Ottawa reaches its key deficit target of $25 billion in 1996-1997—or three per cent of the gross domestic product Depending on economic circumstances, the deficit could even be slightly below that target. Maclean’s has learned that the cuts, which are staged to occur over varying periods, will carve enormous chunks out of the departments of industry, transport and agriculture. Ottawa will also raise fees to recover its costs for such services as ferries and immigration applications. It will reduce unemployment insurance benefits. It will likely increase
its so-called claw-back of the old age pension from wealthy seniors.
And it will redesign its transfers to the provinces, converting much of the money for postsecondary education into student loans. TTie remainder of that education transfer will be combined with the transfers for welfare and health into a single “block fund.”
Taxes will also rise, by a stillundetermined amount. Insiders say that, prior to Christmas, many cabinet ministers and backbench MPs wanted to rely heavily on tax increases to cover the growing cost of interest payments on the federal debt. After meetings with their constituents, however, they concluded that such increases might provoke an open tax revolt Instead, the cabinet has now opted for an increase in the tax on the capital of large corporations and a surtax on high-income earners. It is tightening tax credits, such as those for research and development.
And it is likely to raise gasoline taxes. Already, sources say, the ratio of spending cuts to tax increases is higher than the finance committee’s recommendation of 8:1. But the taxation package is not yet settled. If interest rates appear likely to rise, cabinet will have to resort to further measures such as even higher gasoline taxes. As former senior bureaucrat Arthur Kroeger told Maclean’s: “To do cuts has involved a tortuous process that has run for months and included interaction with stakeholder groups. The only way that you can raise extra money fast when interest rates run off the scale is to go to the tax system.”
The major question, however, is whether such action will be enough to soothe the jit-
Ottawa plans major cuts in health, welfare and education— and some taxes
tery financial markets. Even though Prime Minister Jean Chrétien emphatically maintained last week that his government would meet its deficit targets, the dollar continued its rocky ride. Several days later, as Chrétien began an 11-day trade mission to the Caribbean and Latin America, Bank of Canada governor Gordon Thiessen urged Ottawa to “put government deficits and debt onto a more sustainable track”—and he repeated
his pledge to control inflation. Despite such assurances, the dollar was worth only 70.29 cents (U.S.) at the week’s end. To shore up the dollar, the pivotal interest rate on 90-day commercial paper was 8.5 per cent, more than 130 basis points above the worst-case scenario of 7.2 per cent that Martin foresaw only last October.
Such continuing instability may prod Martin to advance the date of his budget from its ex-
pected release on Feb. 28 to early February. Liberal insiders say that the minister has concluded that assurances are no longer enough. The federal debt is almost $550 billion. That crippling debt has left Ottawa at the mercy of the financial markets: even a single percentage-point increase in interest rates adds $1.7 billion to the annual deficit “We estimate that the federal government now needs to cut about $10 billion to $12 billion over the next two years to meet its targets,” says Ted Carmichael, chief economist for J. P. Morgan Securities Canada Inc. “We are going to have to see what they have come up with, and judge them, before some degree of confidence comes back.” Even then, Ottawa may not be out of the fiscal woods. “I think what people are looking for is not only how we get from here to a $25 billion deficit, but how we get from there to a balanced budget,” adds Warren Jestin, chief economist at the Bank of Nova Scotia. “Markets are not in a ‘tell me’ mood. They are in a ‘show me’ mood.”
Maclean’s has learned that Ottawa is considering the following spending cuts:
• The federal government contributed $6.2 billion to the provinces in 1994-1995 for postsecondary education. Almost $3.9 billion of that amount was in the form of tax points: that is, Ottawa allowed the provinces to collect tax revenue that the federal government used to take in. The remainder—about $2.3 billion—was in cash. But Ottawa has a problem. The value of the tax revenue is growing— because the economy is growing. As a result, the remainder of the transfer, Ottawa’s cash u contribution, is shrinking. And “that means that Ottawa’s chance to play a role in post§ secondary education is also I shrinking.
To retain that role, Ottawa plans to convert much of its cash contribution into student loans in 1996-1997—although the provinces will continue to receive a portion of the funds. Students would only repay the loans when they enter the workforce—and their payments would be tailored to fit their income. Ottawa would save money because it would take several years to loan the entire amount • Ottawa uses the same funding mixture for
health care as it uses for postsecondary education: that is, $8.1 billion in tax points and $7.2 billion in cash in 1994-1995. Because the value of the tax points is growing, the value of the cash contribution is diminishing. But if Ottawa wants to enforce cross-Canada standards in health care, it needs to retain its financial clout. Accordingly, the federal government plans to combine three transfers programs in 1996-1997: a small portion of the postsecondary education funding, health care and the Canada Assistance Plan, which pays 50 per cent of eligible provincial welfare costs ($7.4 billion in 1994-1995).
Ottawa’s new contribution to the provinces would be less than the $16.9-billion sum of the current plans. In last year’s budget, Ottawa vowed to lop $1.5 billion from 1996-1997 levels. liberal insiders now say that the savings will be much higher. In return, Ottawa reasons, the provinces would receive a stable, as opposed to an ever-diminishing, source of health-care and education funds. They would also be given greater leeway in their design of certain programs: provinces, for example, would be allowed to stipulate that social assistance recipients must perform community service.
• The federal government is going to raise its fees for a wide range of services. The fees for ferry services will be raised to cover much of the $160-million tab. Passengers also will face new fees to cover capital projects at airports. Commercial and recreational fishermen will pay more for licences. And prospective immigrants will face hefty application fee increases to recover a portion of the costs of processing them—and the $264-million tab for settlement and Integration services.
• Ottawa will make sizable cuts, perhaps as much as $4 billion, in the $15.6-billion unemployment insurance program. Liberal insiders say that Human Resources Development Minister Lloyd Axworthy is convinced that UI payments have created a “policy-induced equilibrium”: that is, the very structure of the UI system has encouraged workers and firms to tap it regularly as a source of funds, which means, in turn, that workers do not move in search of full-time work. Axworthy also senses that the public is behind him: his tough speeches have received strong applause; and recent federal polls show massive public support for the concept that social-policy reform should save money. As a result, the budget is likely to reduce the period for which workers receive benefits or the amount of their weekly benefits. It might also increase the number of weeks of work that are required to qualify.
• Ottawa will spend $20.6 billion on benefits for the elderly in 1994-1995. The basic old age pension, which goes to all Canadians who are 65 and over, is “clawed back” from wealthier recipients at a rate of 15 per cent of individual income more than $53,215. The full pension is recovered when an individual earns just under $84,000. liberal insiders say that Ottawa intends to increase the severity of the claw-back provision so that more funds are recovered
from Canada’s wealthier taxpayers. (The claw-back netted $400 million in 1994-1995.)
• Spending cuts will affect most departments. Ottawa will cut the $2.3-billion budget for foreign aid, slashing at least 10 per cent over two years. It will trim the $2.7-billion budget for cultural programs, including about $100 million from the Canadian Broadcasting Corp. Although Martin’s last budget lopped $7 billion over five years from the defence department’s budget, it is almost certain that Ottawa will implement its recent white paper, which called for even deeper cuts including a one-third reduction in headquarters personnel and resources by 1999, a $15-billion reduction in the procurement budget over the next 15 years and further reductions in civilian staff, from 25,200 to 20,000 in 1999. Although the white paper did not put a price tag on those cuts, insiders estimated that the 1994-1995 budget of $10.8 billion could face extra cuts of up to 10 per cent over five years.
• The budgets of three departments—agriculture, transport and industry—will be severely trimmed.
The operative word at transport will be “commercialized”: that is, facilities must cover their costs through user fees and better business practices.
Ottawa will lease the 26 airports that carry 94 per cent of Canada’s air passengers. It will “commercialize” the St Lawrence Seaway and some Coast Guard functions. Most of the $590million subsidy for the rail transportation of Western grain will be pared.
Atlantic freight subsidies will be trimmed. More uneconomic branch lines will be closed. The $330-million subsidy for passenger rail will be slashed. As Transport Minister Doug Young has warned: ‘The national dream of iron horses, steel rails and steam is dead.”
The industry department will be heavily hit. A vast array of subsidies, including the $158-million Defence Industry Productivity Program, will be curtailed or abolished. The department’s $1.2-billion budget will be cut to $500 million over the next two years—with a loss of 1,000 to 1,500 jobs. The regional agencies, however, such as the $299-million Atlantic Canada Opportunities Agency, may survive. Regional ministers such as Axworthy and Government Services Minister David Dingwall have apparently argued that their regions deserved to keep such agencies—because they were already bearing a heavy burden from the spending cuts. If they win their battle, funding levels will simply be cut—and future grants may be converted to loans.
The $1.3-billion agriculture budget will be severely pared, including a portion of the $217-million direct subsidy to dairy farmers. The fisheries department will be reorganized into a new oceans department, which will in-
clude the Coast Guard. As last fall’s defence white paper predicted, the Canadian Forces “will devote a significant number of flying hours and ship days to fishery patrols.” That, in turn, will allow Fisheries and the Coast Guard to retire several vessels.
• The cabinet is still divided on the issue of whether to withdraw from the areas of forestry, mining, tourism, housing and recreation. Although Ottawa has always conceded that the provinces have the right to legislate in those fields, some ministers argue that any
withdrawal, prior to the Quebec referendum, would weaken the strength of the federal government. Others argue that such withdrawal would be symbolically important as a sign of federal flexibility. It would also save money, such as the $88 million spent in 19941995 on forestry, because Ottawa is determined to provide no compensation to the provinces if it withdraws. The most difficult area to dismantle is the Canada Mortgage and Housing Corp: most of its $2.1-billion budget is spent on subsidies for existing federal housing stock. Insiders said that because Chrétien has not yet decided where he stands on the transfer, the entire issue may be postponed until after the budget Such massive cutbacks will be controversial in themselves. Coupled with tax increases, they could be enough to scare any politi-
cian. Insiders say that the cabinet is united— so far—because Martin held lengthy one-onone talks with ministers whose departments were severely affected, such as Industry Minister John Manley. They also say that he was sensitive to caucus and cabinet concerns about equity. In response to large increases in bank profits, for one, the budget will increase the tax levied on corporations with more than $10 million in capital. The increase could raise about $400 million in new revenue. Ottawa will also slap a surtax on highincome Canadians.
The government also has a few tricks up its sleeve. Some Liberals are hinting that tax hikes will be far worse than anyone imagines—so that taxpayers will feel relieved on budget day. In particular, they are implying that there may be an across-the-board increase in middleclass taxes, perhaps a percentagepoint increase in one of the three tax brackets. That scenario is actually unlikely—unless interest rates go through the ceiling. The government is also debating measures to put some good news in the budget an increase in the Child Tax Credit of $1,020 for lower-income recipients or a boost in the Working Income Supplement, which adds up to $500 per year to families earning between $3,750 and $25,921.
But Martin has more than politicians to worry about. If the tax increases are too high, the money markets could keep the dollar on a downward slide: $7.5 billion in Canadian debt matures in the first two weeks of March. Says J. P. Morgan’s Carmichael: “The tendency in the financial markets is to believe that deficits only really come down when expenditures are reduced—and that tax increases, of which we have had many over the past decade, have not contributed much to deficit reduction. They just reduce the pressure on the government”
Martin must also worry about the hard-pressed Canadian taxpayer who has heard government promises to control the deficit for years—with few results except higher taxes. Donna Dasko, the vice-president of the Toronto-based polling firm, Environics Research Group Ltd., says that the Canadian mood will be “bleak” if Martin combines massive spending cuts and whopping tax increases. If, however, he limits tax increases, the public may swallow the tough medicine. “Canadians have heard that it is important to reduce the deficit for quite a long time—and it has really sunk in,” she says. “They are not going to be elated. We are not talking about satisfaction with the government or people being happy. But I would think they would find it acceptable.” That glum verdict is the Liberal cabinet’s best hope—and earnest goal. □