The federal budget isn’t as prudent as it might seem

In his budget speech on Tuesday, Finance Minister Jim Flaherty made much of his government’s “financial prudence.” Critics and commentators have also called it a “do-nothing” and “wait-and-see” budget. It is nothing of the sort. Here are three areas where the government is not at all acting in a prudent way.

Social engineering through multiple small changes to taxes: This budget continues the Harper government’s tradition of influencing social behaviour through tax changes. Tax relief for families adopting children is a measure to promote adoptions. The increase in the excise duty on cigarettes (estimated at $675 million next year) is a measure intended to deter smokers. So what’s the problem? Tax systems should be neutral. They should try to influence human behaviour as little as possible. When government tries to influence behaviour through tax changes, it is obscuring real-world incentives toward efficient market behaviour, as well as imposing its own questionable moral views on the population. Why is adoption to be favoured by the tax system over, say, invitro fertilization, or even efforts to promote contraception through a tax rebate for those who buy contraceptives? More important, by allowing itself to manipulate the tax system selectively, the government opens itself to the activities of lobbyists.

The higher tobacco tax is unlikely to reduce smoking, and will certainly increase smuggling and possibly reduce government revenues. It is ironic that this budget, which touts measures to reduce tax fraud in charities, should set itself on the path of promoting massive tax evasion by raising taxes on cigarettes. In the early 1990s, the government learned this lesson the hard way when it tried to increase cigarette taxes only to provoke the greatest boom in cigarette contraband activity in Canadian history — while at the same time losing revenues. The Conservatives risk a similar fiasco.

Ignoring the productivity issue: The budget’s focus is on employment. The real focus should be on productivity. Nowhere does the budget present a serious discussion of the extremely low productivity growth of Canadian labour. Yet it is only upon strong productivity growth that the per capita level of social services can be sustained (given Canada’s greying population), let alone increased in years to come. Instead, the government is banking on solving Canada’s budgetary problems by a massive influx of low-wage immigrant labour.

Productivity is the elephant in the room that everyone is pretending not to see. Per capita revenues in Ontario are lower now than they were 10 years ago. This is a remarkable reversal after almost 200 years of sustained per capita income growth. By ignoring per capita income measures, the government is hiding from Canadians the calamity in social services that is creeping up on them.

Balancing the budget by 2015: Another of Flaherty’s major achievements is supposed to be the return to a balanced budget next year. So what’s the problem? Two words: interest rates. The government’s worst-case scenario for budget imbalance does not consider anything more than a sustained 100-basis-point rise in interest rates. But as the experience of the early 1980s and early 2000s shows, interest rates can shift rapidly by large magnitudes. A large shift in interest rates could push the government rapidly back to the scenario of the 1990s, when debt charges accounted for 30 per cent of total spending, as opposed to 10 per cent today.

Canada does not have the “tax room” left to raise taxes to get out of a bad state of public finances, as it did under the Chrétien government in the 1990s. It is urgent that this government find some means of cutting expenses. Cutting subsidies to businesses as well as privatizing Crown corporations such as Canada Post and VIA Rail, while at the same time ending their respective monopolies, would be a start on the path toward expenditure reduction and long-term fiscal prudence.

Filip Palda is a professor at the École nationale d’administration publique and an associate researcher at the Montreal Economic Institute. The views reflected in this column are his own.