Canada's 2007 Economic Update: A Good Time to Begin Broad-Based Tax Relief

Affordability

Broad-based tax cuts are expensive, and considerable funds must be available for a prolonged period to undertake them. The government can anticipate a fiscal surplus in 2007/08, and every year beyond, which will accommodate a sustainable tax cut plan beginning in January 2008, in the $5–10 billion range for 2008. This plan specifically reserves some room for new spending, as well as some targeted tax relief in Budget 2008. In addition, the government must also reserve sufficient fiscal room for a 1-percentage-point reduction in the GST in 2010/11.

Although the government had been anticipating a significant fiscal surplus in many recent years, it was reluctant to cut taxes because the fiscal forecast did not indicate that sufficient revenues would be available in the outer years to sustain these cuts. In retrospect, we have learned that, in fact, billions of dollars in tax cuts were affordable in previous years. Instead, most of these funds went to unplanned debt reduction. Based on recent fiscal results, this year we are confident that a tax-cut plan in the $5–10 billion range can be sustained.

Debt reduction in 2006/07, at $14 billion, was $11 billion more than the Budget 2006 plan. As a result, the government can now easily attain its goal of reducing the debt burden to 25% in 2012/13, even after introducing the proposed tax relief plan.

From its "Tax Back Guarantee," the government is already committed to at least $700 million in personal income tax (PIT) reductions in 2007/08 and beyond, resulting from the $14 billion debt reduction last year. The PIT reductions recommended in this note for the Economic Statement could be counted against this prior commitment.

Even if program spending increases as much as nominal economic growth in 2007/08 (the high end of the government’s comfort zone for spending growth), without a tax reduction in the $5–10 billion range beginning no later than January 1, 2008, it now appears there will be a fiscal surplus and subsequent contribution to debt reduction well beyond the $3 billion originally planned for 2007/08.

Timing

The fiscal surpluses will be published in the November Economic and Fiscal Update. If these surpluses are not immediately claimed by broad-based tax cuts, pressures from interest groups will be quick and strong to erode them with targeted tax cuts and spending.

To date, most (but certainly not all) of this government's tax relief has been initiated for reasons other than strengthening the economy. Given that, it should be eager to establish more credibility.

It is difficult to argue there are overwhelming logistical difficulties in delivering broad-based tax cuts in the annual fall Economic and Fiscal Update. The Liberals did exactly that, as recently as November 2005.

The Specific Tax Cuts Recommended

• Reduce the lowest marginal rate from the current 15.5% down to 15.0%—a fiscal cost just under $2 billion per year.
• Accelerate the planned reductions in the corporate income tax (CIT) by taking it from the current 21% down to 20% effective January 1, 2008—fiscal cost just under $2 billion.
• Some reduction to marginal rates of PIT at the midrange, such as eliminating the 26% bracket (tax on income between $73,000 and $119,000 would then be 22% instead of 26%)—fiscal cost just over $2 billion.

The government should specifically not use the fiscal room currently available to accelerate the timing of second GST reduction, currently budgeted for 2010/11. This GST cut has some potential to indirectly provide incentive for increased business investment if it can be delivered as part of a package of harmonization of the GST with the provinces.

The personal income tax burden (PIT/personal income) has been fairly level in recent years, but it is much higher than it was in the 1980s and 1990s. The corporate income tax burden (CIT/corporate profits), on the other hand, is very volatile. It is not high by historical standards, but it is high relative to a few years ago.

Economic Impact of Proposed Tax Cuts

The proposed tax reductions are the classic broad-based tax cuts, with the expected positive impacts on the strength of the Canadian economy. Specifically, the proposed cuts will strengthen the incentives for people to seek more and better employment opportunities. On the corporate side, the income tax reduction will increase the incentive for companies to invest and to be innovative. While much of the tax relief is focused on the lowest-income taxpayers, all individuals and families would share in the benefits of this proposed tax relief, as would all corporate taxpayers.