Increasing spending on the Canadian Armed Forces has probably been the most expensive element in the core policy strategy that Prime Minister Stephen Harper has pursued to give his Conservative government its particular personality.
True, cutting the GST was expensive, but most of the niche tax breaks that followed were relatively cheap. And, yes, building prisons might eventually be expensive, but the up-front cost associated with ordering judges to impose mandatory minimum penalties—the spine of the Tory tough-on-crime agenda—is very low. Streamlining environmental assessments and other regulatory requirements for energy and other resource developments generally saves Ottawa money.
But bolstering the military hasn’t come cheap. Department of National Defence spending climbed to $22.8 billion for 2011-12, up from $15 billion when Harper took office in fiscal 2005-06. Last year’s fiscal plan called for more than $1 billion a year to be cut from the defence department’s overall budget of more than $20 billion by 2014-15. This week’s budget will almost certainly continue that trend. But close watchers of defence spending are less fixated on the amounts than the conditions that surround any cuts. They will be listening for signals from Flaherty and his officials on how any reductions must be accomplished.
David Perry, an analyst at Carleton University in Ottawa and with the Conference of Defence Associations Institute, has low expectations for how much clarity Finance Minister Jim Flaherty will bring to the notoriously complex questions of defence spending. “A lot of the times, the budget language is so amorphous that it can mean essentially whatever you want it to,” he says.
Still, Perry says he will be listening closely for any hint of whether the government might ease off on insisting the force’s troop strength be maintained at 68,000 in uniform, or allowing for some scaling back of the ambitious plans for buying new military hardware—planes, ships, helicopters and more—first mapped out in 2008.
If those two major conditions—no shrinking the forces and no cutting back on procurement—remain, then something else has to give. Perry says there are only two other major ways to save: reduce the training and readiness of troops, or take a serious look at reforming the defence department’s administration. The latter option was proposed in Lt. Gen. Andrew Leslie’s controversial 2011 “transformation” report, a detailed blueprint for major savings in the department’s sprawling head office operations in Ottawa.
Leslie has since retired, but has spoken out recently to criticize the government for allowing the defence department’s use of outside consultants and private contractors to grow in the past few years. And that’s only one indication that his report isn’t being implemented.
Perry says if Leslie’s recommendations aren’t revived, allowing major administrative cuts, the military will have to find the savings Flaherty is demanding in their front-line operations. And that could mean Canada will end up with “hollow” forces—troops who are being paid to remain in uniform, but not trained or kept ready to a degree that makes them usefully available to be deployed.
Flaherty can’t be expected to give a detailed plan for military cost savings in this week’s budget. But with defence spending under increasingly close scrutiny—and the Tories’ reputation as staunchly pro-military hanging in the balance—any signal he sends on how cuts are meant to be accomplished would be a key budget-day story.
Is it possible for a potential budget measure to be too obvious, the consensus behind it too broad? When it comes to the pressure to spend heavily on infrastructure, Flaherty might just be faced with this unlikely problem. The difficulty he faces is that so many groups have urged him to invest in infrastructure that almost anything he delivers on that front risks being judged inadequate.
Indeed, Flaherty recently tried to remind enthusiasts that no matter how compelling the case for infrastructure spending, the dollar amounts will be tempered by his continuing emphasis on shrinking the deficit. When it comes to infrastructure, Flaherty told the Economic Club of Canada, “Any decision will be made in the context of our current fiscal situation.”
While many economists and lobby groups have issued recommendations on infrastructure spending, arguably the dominant voice is the Federation of Canadian Municipalities (FCM), which speaks for the cities and towns responsible for the lion’s share of spending on public works—from routine sidewalk paving to erecting conference centres and building mass-transit systems.
The FCM’s pre-budget position is that the federal government should ramp up its funding to municipalities for infrastructure to $5.75 billion a year, about $2.5 billion more than Ottawa currently contributes, and to lock in that funding for up to two decades to allow for long-term planning. It’s a big ask, but the Conservatives have, partly out of necessity, developed a strong working relationship with city politicians over the past five years.
The turning point was Flaherty’s emergency budget in 2009, a massive gush of deficit spending designed to blunt the impact of that year’s recession. A major part of the plan was the swift implementation of a multi-billion-dollar infrastructure plan, much of it needing co-operation from municipal governments. The Tories deemed the plan a huge success, especially since they were able to exploit it to political advantage with a massive advertising campaign and distinctive blue and green signs on construction sites.
Three major questions loom over Flaherty’s budget measures on infrastructure:
• Will the spending be committed over a long enough period to satisfy the demands of mayors for predictability? The FCM wants a 20-year plan. Anything less than 10 years might expose Flaherty to criticism.
• How close will Flaherty get to that $5.75- billion-a-year a target set by the FCM? He wants to balance the books by 2015, the likely year of the next federal election, so it’s possible he’ll spend less in the next two or three years, but will set course for more spending later on.
• How much of any new infrastructure money will be earmarked for basic stuff—unglamorous paving and digging and fixing-up—and how much for splashy projects—sparkling new facilities that let politicians bask in the favourable local publicity?
Those are the sorts of questions infrastructure experts will be asking on budget day. Flaherty, though, might well be demanding that they keep something else in mind. Although the attention is likely to be focused on new cash transfers, he’s expected to require credit for the government’s move to make permanent a $3 billion annual transfer of gas tax revenue to the municipalities. That’s exactly the sort of predictable, substantial funding municipal governments plead for—but also the sort that federal politicians can’t easily plant a sign on to claim their share of the credit.
Looking back on the economic policy of the early months of the Harper government in 2006, the mood now seems almost charmingly naive. Rather than worrying about deficits and tepid growth and European market anxieties, Flaherty released an upbeat plan called Advantage Canada, a blueprint for lower taxes, less debt and long-term investments in skills, competitiveness and infrastructure.
Few think back on Advantage Canada these days. After the market meltdown of 2008 and the recession that followed, Flaherty shifted to emergency stimulus spending, ramping up the deficit. Infrastructure spending was less about future prosperity and more about immediately staving off a prolonged slump. In the provinces, which have the main direct responsibility for training, pressing worries pushed aside thinking beyond the next quarter—or the next election.
But with Budget 2013 set to be delivered on March 21, Flaherty might again be thinking about what some call a growth agenda. Although private-sector economists have recently turned more pessimistic about 2013’s outlook, revising projections for the uptick in Canada’s gross domestic product to below 2%, Flaherty denies stagnation is a “long-term concern” for Canada.
If he is truly confident that the economy isn’t in dire need of immediate support, Flaherty might turn his attention to generational issues. Prime among them, he has signalled, is training. Already in its immigration and Employment Insurance reforms over the past year, the Harper government has moved to try to connect workers with jobs—and now Flaherty seems eager to make sure provinces are on the same wavelength.
“What we will do is focus on our top priority, jobs and economic growth, by helping more Canadians find jobs and participate fully in the workforce,” he said early this month. “Several studies suggest that changing demographics and evolving economic conditions mean that we need to make sure that people have the right training and skills for jobs today.”
His aim seems to be to make provinces more accountable to Ottawa for how they spend the more than $2 billion the federal government sends them every year for training. One strong possibility is that he will insist on renegotiating labour-market development agreements, which mainly cover training programs paid for under the Employment Insurance program.
While provinces might rankle against any new demands, few independent economists are likely to quibble with a federal push to make sure training connects Canadians with actual jobs. But some will view a skills-based growth strategy as insufficient to spur economic activity right now.
David Macdonald, senior economist at the left-leaning Canadian Centre for Policy Alternatives (CCPA), argues that tepid growth means poor prospects for nearly 1.4 million unemployed Canadians. Macdonald urges immediate stimulus measures, starting with infrastructure spending, which he says would result in the fastest immediate job creation. For instance, the CCPA’s annual “alternative federal budget” proposes $1.35 billion a year for public transit alone, along with a raft of other infrastructure ideas.
While Macdonald emphasizes measures that would take effect right away, other economists stress the need for thinking about changes that would take longer to shift Canada onto a stronger growth path. Glen Hodgson, chief economist of the Conference Board of Canada, favours infrastructure spending, too, but also urges “a fundamental review of our tax system, making sure our system is geared toward supporting growth.”
Whatever growth message Flaherty aims to send in Budget 2013 on themes like skills, infrastructure and taxes will be tested against how he calibrates program spending. With the economy only barely expanding, mainstream private-sector economists, who often like the sound of restraint, are actually worried this year about any further squeezing of departmental spending.
“It probably would be unwise for the federal government to step on the brake further than it already has,” BMO Capital Markets chief economist Doug Porter said after a recent meeting with Flaherty.
As the longest-serving minister in Harper’s cabinet, and the longest-serving finance minister in the G7, Jim Flaherty gets a lot of respect these days. After all, Flaherty has weathered extraordinarily tough economic times, and Canada has, as he never tires of mentioning, fared better than most countries. Still, when it comes to tax policy, he doesn’t always get much respect.
Adjectives commonly attached to the tax measures adopted by the Harper government include “boutique,” “niche,” and “gimmicky.” It started with the two points the Tories shaved off the GST in their early years—popular with voters but derided by economists who think consumption taxes are best. Then came all the tweaking—credits for children’s fitness courses and public transit, deductions for tools and textbooks.
From a finance minister who likes to talk about fundamentals, all these looked more like frills. But is the time right for a major shift toward big thinking rather than tactical tinkering? There are signs pointing in that direction. Late last year, the House of Commons finance committee, which is dominated by Conservative MPs and chaired by respected Alberta Tory MP James Rajotte, called for the government to set up a royal commission to conduct a sweeping review of the Income Tax Act. Rajotte said Flaherty was open to the concept.
Many lobby groups join the MPs’ call for comprehensive efforts to simplify the tax code. The Canadian Chamber of Commerce, for example, bemoans “ad hoc changes to tax legislation by successive governments.” The group counts some 260 exemptions, deductions, credits and rebates offered now, and argues that a rational tax system would eliminate many of them and instead lean toward as low a tax rate as is possible spread over a broad, uncomplicated base.
The Conference Board’s Hodgson calls for “reinventing” the tax system. He expects only incremental changes in Budget 2013, but suggests the moment might be right for the start of a more ambitious review. One possible outcome sketched in a recent Conference Board report: keep the same three-bracket system for personal income taxes as there are now, but with lower rates in exchange for far fewer loopholes and exceptions.
Is Flaherty really game for a major review? In a recent speech to the Economic Club of Canada, he was hardly apologetic about his record on tax policy to date. Flaherty boasted he’s given Canada the lowest tax rate on business investment in the G7, helped Canadians who most need a tax break with the Registered Disability Savings Plan, allowed seniors to split their incomes for tax purposes and—“most important”—introduced tax-free savings accounts.
All that sounded like a robust defence of what critics might call a piecemeal tendency on taxation but Flaherty, evidently, considers it a strategic approach. For those hankering for a clear change in direction, the finance minister might have been sending a very different signal.
And even if Flaherty decides not to embark on any fundamental rethink of Tory taxation policy, at least one significant move in Budget 2013 is all but certain—more funding for the Canada Revenue Agency to hunt down cheaters who stash money in foreign tax havens. “People shouldn’t be hiding money from the government of Canada. Some people do that offshore,” Flaherty said recently. “And sometimes it makes sense to invest more resources, for example, in the Canada Revenue Agency so that we are better at policing the minority of Canadians who do not pay their fair share.”
Running massive deficits wasn’t supposed to have been in the cards when Harper made Flaherty his finance minister back in February 2006. A global credit crisis and the world recession it ushered in reshuffled the economic deck. Restoring the federal books to balance must now rank among Flaherty’s main goals.
But is the drive to erase the deficit by the Tories’ target of 2015—not coincidentally, the likely year of the next federal election—more motivated by economic fundamentals or political symbolism? Economists asked by Maclean’s were divided.
Macdonald at the Canadian Centre for Policy Alternatives sees deficit-slaying as a distraction from the more pressing task at hand: promoting job-creating growth. “From an economic perspective, the deficit is so small that the debt-to-GDP ratio is falling,” Macdonald says. “It’s entirely political.”
The Conference Board’s Hodgson argues that eliminating the deficit is a key goal beyond any political symbolism attached to it, if only because more debt means more interest payments, reducing the government’s capacity to spend on other priorities.
But Hodgson says Flaherty’s ability to hit that 2015 target will be made difficult by slow growth and the resulting lower tax revenues. “It’s a very turbulent time. The growth forecasts are going to be tepid,” he says. “So it’s going to be very tight.”
As well, Flaherty allows himself very little flexibility to restrain spending, essentially limiting himself to cutting programs Ottawa delivers itself, rather than curbing the money it gives to Canadians and their provincial governments. “We are not going to reduce transfers to individuals, including seniors and children. In fact, we continue to increase them,” he said in a key speech last month. “The next big pool of spending is transfers to the provinces and territories. The previous government reduced that spending in order to balance the budget. That creates hardship in education, social services and health care, so we will not do that. We will not reduce the transfers to the provinces.”
That leaves federal programs. In last year’s budget, Flaherty slashed $5.2 billion out of $75.3 billion that federal departments spend on their own programs. The cuts ranged from a low of 1.1% out of Veterans Affairs and 2.7% from Aboriginal Affairs, to deeper reductions, such as the 10.7% cut at Transport Canada and 9.7% taken from international assistance. How much Budget 2013 cuts, and where the axe is aimed, is a major question as Flaherty tables his new fiscal plan this week.
Even though Canada’s federal deficit looks manageable by international standards, the numbers still look daunting. In his fiscal update last fall, Flaherty predicted a 2012-13 deficit of $26 billion. For 2013-14, the deficit is expected to be about $10 billion less than that. Shrinking it to zero by 2015 looks doable—but troubling variables cloud the outlook. For instance, Flaherty has admitted that the heavily discounted price being applied to Canadian crude oil—a serious fiscal problem for Alberta—is also hurting Ottawa’s revenues.
Here’s one last thing to consider as Flaherty prepares to unveil his budget: the federal tax haul last December (the latest figure available) was up 2.8% over the same month a year earlier—but still below the 3.8% rise in federal spending. And the main driver of that increased spending? Those very same transfer payments Flaherty vows never to squeeze.