Ot­tawa Needs to Fo­cus on Busi­ness In­vest­ment and Eco­nomic Growth

Policy - - In This Issue - Per­rin Beatty

One of the po­lit­i­cal bat­tle­fields in the Cana­dian bud­getary process is the ques­tion of how busi­ness—big, medium and small—gets treated in the strate­gic land­scape of any gov­ern­ment’s fis­cal pri­or­i­ties, within and be­yond the usual Lib­eral and Con­ser­va­tive clichés. As Pres­i­dent of the Cana­dian Cham­ber of Com­merce, Per­rin Beatty pro­cesses ev­ery bud­get through that lens. Here’s his in­valu­able in­sight into the 2018 bud­get.

If ever there were any doubt about why the fed­eral gov­ern­ment needs to ur­gently en­act pol­icy mea­sures aimed at boost­ing busi­ness in­vest­ment and eco­nomic growth, look no fur­ther than its re­cent bud­get. Lots and lots of new spend­ing ini­tia­tives were an­nounced. How­ever, the fun­da­men­tal ques­tion about how we pay for them was left up in the air. Bor­row­ing more and run­ning higher deficits just punts the prob­lem into the fu­ture. And, as the gov­ern­ment it­self at­tests, there are sig­nif­i­cant risks that lie ahead for the Cana­dian econ­omy. Ot­tawa missed an im­por­tant op­por­tu­nity to set a clear path in its bud­get to­wards mit­i­gat­ing those risks. Now, it needs to turn its at­ten­tion to the growth side of the equa­tion. And it needs to do so quickly.

Bud­get 2018 was all about spend­ing—new spend­ing ini­tia­tives and en­hanced spend­ing for pro­grams that aim to: sup­port low-wage Cana­di­ans; ad­dress gen­der in­equal­ity; sup­port First Na­tions de­vel­op­ment; strengthen Indige­nous rights and self-de­ter­mi­na­tion; pro­mote skills and re­search; im­prove health and en­vi­ron­men­tal stew­ard­ship; and en­hance jus­tice and se­cu­rity. These are all laud­able goals. Cana­dian busi­nesses stand to ben­e­fit from mea­sures to sup­port women en­trepreneurs, small busi­ness growth, skills train­ing, in­no­va­tion, and cy­ber­se­cu­rity. There will also be some im­por­tant pol­icy im­prove­ments made, par­tic­u­larly with re­spect to the tax treat­ment of small busi­ness and sim­pli­fi­ca­tion of busi­ness sup­port pro­grams.

What is miss­ing, how­ever, is any con­sid­er­a­tion of the fun­da­men­tal is­sues that ev­ery busi­ness per­son must take into ac­count ev­ery day. Where is the plan to bal­ance the books? How do we man­age the risks that lie ahead? How do we grow? For the fed­eral gov­ern­ment, how do we en­sure a fis­cal and reg­u­la­tory en­vi­ron­ment that en­cour­ages busi­nesses to in­vest, em­ploy, and grow—in other words, to create the eco­nomic wealth re­quired to pay for Ot­tawa’s am­bi­tious spend­ing plans.

The gov­ern­ment is bet­ting heav­ily on a buoy­ant econ­omy to fund its spend­ing ini­tia­tives and meet its newly ad­justed fis­cal tar­gets. The gov­ern­ment’s fis­cal pro­jec­tions are pretty much in line with cur­rent trends. As a per­cent­age of GDP, fed­eral spend­ing and tax rev­enue pro­jec­tions for the next five years look very much like the re­al­ity of the past five years. And, based on those as­sump­tions, the gov­ern­ment’s debt-to-GDP ra­tio is ex­pected to con­tinue its grad­ual de­cline slightly by 2022, even though Ot­tawa will be ring­ing up close to $80 bil­lion dol­lars in ad­di­tional debt.

The prob­lem is that the econ­omy is un­likely to main­tain its cur­rent course at near- full ca­pac­ity. The bud­get’s rosy eco­nomic as­sump­tions will be put to the test by the risks the gov­ern­ment it­self iden­ti­fies—grow­ing pro­tec­tion­ism and un­cer­tainty over NAFTA ne­go­ti­a­tions, tight­en­ing mon­e­tary poli­cies world­wide, and the risk that higher in­ter­est rates pose for an al­ready overex­tended house­hold sec­tor in Canada. Re­cent U.S. tax re­forms are another se­ri­ous risk to busi­ness in­vest­ment in Canada that is miss­ing from the bud­get’s cal­cu­la­tions—we await fur­ther anal­y­sis.

It’s time for a re­al­ity check. Given the risks that lie ahead, it would be a mir­a­cle if the Cana­dian econ­omy were to meet the ex­pec­ta­tions set for it over the next five years in terms of ei­ther em­ploy­ment or growth. Not only

would it defy the busi­ness cy­cle, but it doesn’t make sense in light of the gov­ern­ment’s ob­jec­tive of en­cour­ag­ing cur­rently un­der­rep­re­sented groups to join the labour force. Chances are that the deficit will be much higher than ex­pected. The Em­ploy­ment In­sur­ance Ac­count will be the place to watch. With new pro­grams that will be funded from EI, higher than ex­pected un­em­ploy­ment will trans­late rapidly into a deficit in the ac­count, and even­tu­ally into higher pay­roll taxes for Cana­dian busi­ness.

Higher in­ter­est rates are another risk that is un­der­played in the bud­get. The Cana­dian gov­ern­ment’s long bond rate is al­ready near the av­er­age level pro­jected for the year ahead and it is mov­ing higher in line with rates in the U.S. With Cana­dian house­hold debt at record lev­els, even a slight jump in long-term in­ter­est rates—which in turn af­fect mort­gage and other long-term bor­row­ing rates—is likely to have a sig­nif­i­cant neg­a­tive im­pact on con­sumer spend­ing and the hous­ing mar­ket in Canada. The gov­ern­ment es­ti­mates that a one per­cent­age point in­crease in the cost of bor­row­ing would lead to a $3 bil­lion in­crease in the fed­eral deficit over a pe­riod of five years, and that does not take into ac­count the im­pact that higher in­ter­est rates would have in slow­ing down con­sumer de­mand and eco­nomic growth. The con­tin­gency re­serve the bud­get re­in­stated to guard against eco­nomic risk might well be con­sumed by higher in­ter­est charges alone.

The fed­eral gov­ern­ment is ill-pre­pared to man­age a pe­riod of ris­ing in­ter­est rates or eco­nomic weak­ness. While over­all fed­eral spend­ing as a per­cent­age of GDP is ap­prox­i­mately the same to­day as it was 10 years ago, the struc­ture of the gov­ern­ment’s ex­pen­di­tures has changed sig­nif­i­cantly. As in­ter­est rates de­clined, gov­ern­ment spend­ing in the form of grants to other lev­els of gov­ern­ment and so­cial ben­e­fits in­creased to fill the void. The lee­way to re­duce taxes and in­crease spend­ing pro­vided by an era of low in­ter­est rates is now at an end. To­day, there is lit­tle dis­cre­tionary room left for the fed­eral gov­ern­ment to in­crease spend­ing in the face of an eco­nomic down­turn with­out sig­nif­i­cantly in­creas­ing its fis­cal deficit and in turn gen­er­at­ing higher in­ter­est costs at the ex­pense of real eco­nomic stim­u­lus.

Ex­pe­ri­ence has taught us that gov­ern­ments can’t spend their way to pros­per­ity. It’s time to go back to ba­sics— to bal­ance spend­ing with mea­sures that stim­u­late busi­ness in­vest­ment and eco­nomic growth. And that be­gins by en­sur­ing a com­pet­i­tive tax and reg­u­la­tory en­vi­ron­ment for busi­nesses to in­vest here in Canada.

First step? Fo­cus on re­duc­ing bar­ri­ers to growth. Adopt world class reg­u­la­tory prac­tices that min­i­mize com­pli­ance costs while max­i­miz­ing the ef­fi­cacy of reg­u­la­tions. Elim­i­nate reg­u­la­tory bar­ri­ers within our own econ­omy and move full force ahead in evening the play­ing field and achiev­ing greater mar­ket ac­cess in our in­ter­na­tional trade agree­ments. Above all, put in place a tax struc­ture that not only makes Canada com­pet­i­tive with other ju­ris­dic­tions like the United States that are low­er­ing busi­ness tax rates, but which in­cor­po­rates pro­vi­sions that en­hance in­vest­ment in pro­duc­tive as­sets—im­me­di­ate ex­pens­ing of cap­i­tal in­vest­ments and tax cred­its for high-risk in­vest­ments in new tech­nolo­gies and skills train­ing come to mind—and which min­i­mize tax com­pli­ance costs.

In order to do that, the gov­ern­ment needs to en­gage with busi­ness. It needs to rec­og­nize that busi­ness prof­its are im­por­tant to the Cana­dian econ­omy. They gen­er­ate jobs. They are the main­stay of pros­per­ity for the mid­dle class—and for all Cana­di­ans. When busi­nesses are prof­itable they grow, create jobs, and in­vest in the new prod­ucts, pro­cesses, and tech­nolo­gies re­quired to meet cus­tomer and stake­holder ex­pec­ta­tions while re­main­ing com­pet­i­tive.

The record of the past 30 years speaks for it­self. The more prof­itable Cana­dian com­pa­nies are, the lower Canada’s rate of unem-

The gov­ern­ment es­ti­mates that a one per­cent­age point in­crease in the cost of bor­row­ing would lead to a $3 bil­lion in­crease in the fed­eral deficit over a pe­riod of five years, and that does not take into ac­count the im­pact that higher in­ter­est rates would have in slow­ing down con­sumer de­mand and eco­nomic growth.

ploy­ment has been. Changes in prof­itabil­ity (mea­sured in terms of af­ter­tax prof­its as a per­cent of GDP) are fol­lowed im­me­di­ately by changes in the un­em­ploy­ment rate. Canada’s un­em­ploy­ment rate goes up only when profit mar­gins come un­der pres­sure. Un­em­ploy­ment only goes down when profit mar­gins im­prove. Cor­po­rate prof­its also drive cap­i­tal in­vest­ment by Canada’s busi­ness sec­tor. Changes in the amount that busi­nesses in­vest in non-res­i­den­tial struc­tures, ma­chin­ery, and equip­ment fol­low closely on changes in af­ter-tax prof­its. The most ef­fec­tive thing that gov­ern­ments can do to en­cour­age com­pa­nies to in­vest more in in­no­va­tion, pro­duc­tiv­ity-en­hanc­ing tech­nolo­gies, and im­proved en­vi­ron­men­tal per­for­mance is to leave more money in the hands of busi­ness to make those in­vest­ments.

That is why we ur­gently need a com­pre­hen­sive re­view of Canada’s tax sys­tem. It’s why we need a thor­ough re­form of our reg­u­la­tory sys­tem. Canada needs a busi­ness in­vest­ment strat­egy that sup­ports am­bi­tious pub­lic sec­tor in­vest­ments in health care, so­cial pro­grams, in­clu­sive­ness, the en­vi­ron­ment, se­cu­rity—even in­no­va­tion. Now more than ever, that must be the fo­cus for the fed­eral gov­ern­ment over the year ahead.

The record of the past 30 years speaks for it­self. The more prof­itable Cana­dian com­pa­nies are, the lower Canada’s rate of un­em­ploy­ment has been.

FED­ERAL EX­PEN­DI­TURES AS A PER­CENT OF TO­TAL SPEND­ING

Chart 1: PROF­ITS CREATE JOBS

Chart 2: PROF­ITS DRIVE BUSI­NESS IN­VEST­MENT

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