Budget Priorities for Canada:Time for Some Big Ideas?

Robin BoadwayQueen’s University

Introduction

• Budgets oscillate among three types– Waves of major transformative change– Periods of consolidation and responses to crises– Episodes of populism and political compromise

• Periods of transformative change– 1950s & 60s: establishment of federal social

programs and federal-provincial architecture– Late 1980s & 90s: major reforms of trade, taxation

and public indebtedness

Sound Policies vs. Populism• Good budget initiatives typically unpopular (FTA, GST)• Political constraints as an excuse for bad policies?• Why do some sound policies get enacted in the face of

public opposition, and not others?– Literature on political economy provides no answer– Quality and persuasiveness of politicians– Foresight & ideas of bureaucrats– Role of outside critics

• Political constraints endogenous: political consensus requires political leadership informed by thoughtful bureaucracy and credible policy critics

Time for Big Ideas?

• We have gone through a period of relatively populist , politically driven and now crisis driven budgets

• There are some big challenges ahead: may be time for some transformative budgeting

• Begin with brief review of past episodes and the turn to current challenges and options

Transformative Reforms of 50s/60s

• Universal health care• CPP/QPP• CAP and Universal UI/EI • OAS/GIS• Equalization• Tax Collection Agreements• Income tax reform

Transformative Reforms of 80s/90s

• Free Trade Agreements– Watershed in accepting primacy of markets – Supported by system of social protection

• Goods and Services Tax– Complement to free trade– HST/QST model of harmonization

• Controlling public indebtedness– Related reforms to CPP, tax saving for retirement

Other Fiscal Innovations

• Refundable tax credits– Child based– Employment income based

• Consolidation of fiscal transfers: EPF/CHT/CST– Unfinished business (PSE)

• Reform of Equalization (?)• Evolution of tax collection agreements• Major disappointment: Business tax reform

Five Emerging Fiscal Challenges

• Inequality and Poverty• Income Tax Reform• Human Capital• Natural Resources• Carbon Pricing

1. Inequality and Poverty

• Inequality widening (esp at top and bottom)• Poverty rates increasing• Real welfare incomes declining since 1989,

and 60-70% less than poverty rates• Tax-transfer system less progressive and less

effective than other OECD countries• Decentralization has been important factor:

welfare & disabled vs. children, old, workers

Some Policy Options

• General: More targeting, less universality• Focus especially on poverty reduction• Refund and income test all tax credits• Steep marg. tax rates at bottom (after WITB)• Welfare reform: benchmark and index rates;

relax asset limits and work incentives• Harmonize fed-prov transfers (via CST?)• Deal with decline in DB pensions (opt-out?)

2. Income Tax Reform

• Basic reform long overdue– Circumstances have changed: globalization,

mobility– Major reform initiatives launched elsewhere (EU)– Thinking about ideal tax system has evolved since

Carter– Reforms have so far been piecemeal– Time for thorough rationalization of the system

Income Tax Reform, cont’d

• Basic principles– Little support for comprehensive income tax– Two camps: Progressive consumption taxation vs.

Nordic-style dual (schedular) income tax

• Preferred option: Nordic Dual Tax– Progressive earning tax + flat tax on capital income– Gets at main source of inequality– Gets at capital income from inheritances– Correlation of capital income with earning ability

Dual Income Tax, cont’d

• Administrative simplicity – Withholding tax on capital income– Integration with corporate tax

• Further advantage in federal context– Joint federal-provincial earnings tax– Federal capital income tax

• Other direct tax reforms– Ideally, an inheritance tax as a complement to low

capital tax rates

3. Human Capital Investment

• Endowment of human capital and ability to accumulate it unevenly distributed, and correlated

• Human capital accumulation affected by social environment

• Human capital accumulation risky• Liquidity constraints may affect access to

human capital investment

Government Interest in HC

• Market failures– Externalities of knowledge creation and diffusion– Uninsured risk and liquidity constraints– Under-investment for behavioral reasons– Redistribution to equalize outcomes from unequal

endowments and accumulation: incentives to acquire HK + progressive tax

– Equality of opportunity (Sec 36(1)): persons of equal skill & motivation have equal opp. (minimal)

Human Capital Policy Observations

• Tax treatment already generous• Rationalize and harmonize student support– Income-contingent loans for risk & liquidity– Build on Canada Student Grant program– Rationalize tax preferences for targeting– Case for subsidizing borrowing low (RESP)

• Overlapping federal-provincial roles• Separate PSE from CST (?)

4. Natural Resources

• An enormous challenge for the federation• Potential for Dutch disease, especially if

rents not saved• Complicated by provincial resource

ownership– Large horizontal fiscal imbalances– Potential for competitive province-building

• Politics challenging given NEP

Natural Resource Policy Options

• Limited federal options, few palatable• Reform of CHT/CST to extract revenue from

haves (net equalization)• Increase size of vertical gap• More federal taxes from resource firms

(Corporate tax as rent tax: ACE)• Federal counter to province-building• Incentives for provinces to save rents

5. Carbon Pricing

• Many, many intractable issues– Should/could pricing and emissions policy mimic

Stern Report? – Carbon Tax versus Cap-and-Trade?– Single versus multiple stage, compliance– Coverage (agriculture, industrial, household)?– Federal-provincial harmonization?– International harmonization?– Capture and use of double dividend?

Carbon Pricing, cont’d

• Complementary role of technology and adaptation: federal investment?

• Supply side issues:– Reserves of low-cost oil sufficient to take CO2 in

atmosphere to dangerous levels (Stern): Implications for oil sand extraction? Yes or no?

– H-W Sinn: increasing carbon price accelerates extraction; skepticism about deterring emissions

• Discounting costs to future generations?

Concluding remarks

• Important fiscal challenges ahead• Loss aversion leads to opposition to reasonable

policies that deter lazy or populist government s• Good policies rely on integrity of politicians and

advisors in bureaucracy and outside• Policy research community should also

stubbornly insist on basing our policy research and prescriptions on principles and not be deterred by issues of political feasibility