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FINA Committee Report

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CHAPTER 2


A. ENSURING FISCAL SUCCESS

1. Prudent Budgeting

Federal budget making is now very different than it was only five years ago. The reforms adopted by the government were vital to achieving the recent reductions in the federal deficit. Witness after witness told the Committee how important it was for the government to continue to beat its deficit targets, and how doing this in recent years has greatly enhanced the credibility of the government in the eyes of financial markets, as well as those of the business sector and individual Canadians. Credibility is important in enabling the government to signal its intentions to the private sector. More importantly, a credible and prudent fiscal policy helps to keep interest rates in check, which in turn helps the government avoid tax increases. It also helps Canadian families directly because it reduces the costs of home ownership and lowers financing costs associated with the purchase of other consumer durables.

1.1 Contingency Reserve


"I think the Minister and the Department of Finance are doing a very commendable job on their economic forecasts and the assumptions they're making."

Mr. Dale Orr (Individual Presentation)


The prudent economic assumptions used in past budgets were established in the following manner. Prior to the publication of the budget and the preparation of the Economic and Fiscal Update, private sector forecasters were surveyed with respect to their expectations regarding future economic conditions. In recent years, this sample has comprised 15 to 21 respondents. The prudent assumptions used by the government added 80 basis points to the private sector average forecast for short-term interest rates and 50 basis points to the private sector average for long-term interest rates. This Committee recommended in its first consultation report that the prudence factor be between 50 and 100 basis points. In the past, the government has used a prudence factor of as low as 50 basis points for short-term rates.

This practice had two significant effects. The government's calculation of its debt servicing costs were raised as a result, and along with it, estimates of the size of the deficit - for example, a 100 basis point increase in interest rates adds $1 billion to the deficit in the first year.The assumption of higher interest rates also reduced the government's estimates of economic growth, leading to estimates of lower revenue and higher spending estimates. The 1997 budget contained prudent assumptions about nominal GDP growth that were 20 basis points lower than the private sector average for 1997 (4.7% vs. 4.9%) and 60 basis points lower for 1998 (4.1% vs. 4.7%). Sensitivity analysis contained in that budget indicated that a one-percentage point decrease in the nominal growth rate would increase the deficit by $1.3 billion. For the second year of the government's planning horizon, these prudent assumptions would increase the government's estimate of the deficit by about $2.5 billion.

The second component of prudent budgeting was the explicit inclusion of a Contingency Reserve. Initially, the government used a $2.5 billion Contingency Reserve for year one in its two-year planning horizon and a $3 billion reserve for year two. The higher reserve was justified because of the greater uncertainties that exist when planning further into the future. This approach was changed slightly in the 1997 budget, with a $3 billion Contingency Reserve used for both years of the planning period.

A $3 billion Contingency Reserve protects against the first-year effects of a 300 basis point increase in interest rates or a 2.3 percentage point decrease in nominal GDP growth. Prudent economic assumptions and the Contingency Reserve provide a $4 billion deficit cushion in year one of the budget horizon and a $5.5 billion cushion in year two.

The government's current policy does not allow the Contingency Reserve to be used to finance program spending. If it is not needed, it has gone to reduce the deficit. The Minister of Finance told the Committee that the same principle would apply to a Contingency Reserve in an era of budgetary surpluses. If it is not needed, it will be used to reduce the Government of Canada's net debt.

The Committee believes that the practice of prudent budgeting should continue - it is as vital in a world of debt reduction as in a world of deficit reduction. Moreover, many of the economic, financial and political risks that existed a few years ago will still be present in the future. The short-lived stock market turmoil at the end of October and the current events in Asia are examples of such risks, which often originate outside Canada and are beyond our control.


The budget will be balanced by no later than 1998-99.

In the few short years that this Committee has been holding pre-budget consultations, we have been told repeatedly that governments must use prudence when drafting budgets. Of course, prudence is always appropriate. Consider that interest rates are still near their historically low levels, and are more likely to go up than to fall. And, while inflation remains under control in most nations, (reducing the chances of a recession triggered by monetary policy) and while the near-term outlook for the Canadian economy is excellent, the possibility of an economic slowdown grows every year. The North American economies are well along in their recovery, and the American economy is likely operating at or above its capacity. American growth rates are thus bound to decline, which will undoubtedly impact Canada's economy. And, of course, political uncertainty is always a factor to be considered.

Of course eliminating the deficit will not lessen the importance of prudence. While federal deficits contributed to economic risks in the past, they were only part of the equation. We still have highly indebted governments, and until that indebtedness declines substantially, the government sector will continue to be a source of potential financial risk. Even though the federal government has made its debt structure more manageable, the sheer size of the debt and the heavy debt-servicing burden means that a very large portion of government spending continues to be beyond its direct control.

Thus, while we do not see any increase in the risks to budget making, we do not think they have disappeared, or even declined substantially. Recent practice has served Canadians well and it should be continued. As the government has increased the term-to-maturity of its average debt outstanding, we believe that it should be able to increase the prudence factor with respect to longer-term interest rates when circumstances warrant, as it does with short-term interest rates. We believe that the following recommendations should help to ensure that the federal government never again runs a deficit after 1997-98.

Thus, the Committee makes the following recommendations.


    RECOMMENDATIONS


  • The Committee recommends that the Government of Canada continue to use prudent economic assumptions in the formulation of the budget.
  • The Committee recommends that assumptions about both short- and long-term interest rates should be 50 to 100 basis points higher than the private sector average. The Minister should alter the prudence factor as circumstances warrant.
  • The Committee recommends that the government continue to employ a Contingency Reserve, which should be set at $3 billion per year. As at present, the Contingency Reserve should not be used to fund either increased program spending or tax cuts.

2. Budget Targets


The deficit for 1996-97 was $8.9 billion - down $19.7 billion from 1995-96. This represents the largest year-over-year improvement in Canadian history.

Another of the government's budgeting innovations was the replacement of the traditional five-year projections with two-year rolling targets. The five-year forecasts were abandoned because of the inability of the government to accurately project that far into the future. The results frequently proved to be so inaccurate that the entire process of longer-term projections lost all credibility. On the other hand, two-year rolling targets are sufficiently immediate that the economic data upon which they are based is much more accurate, so only extraordinary events would excuse any failure to meet them. This practice also prevents the government from delaying required action until later in the planning period. As the Minister of Finance has stated on numerous occasions, these targets help to provide a standard to which the public can hold the government accountable.

The Committee believes this practice has served Canadians well and should be continued.

Thus, the Committee makes the following recommendation.


    RECOMMENDATION


  • The Committee recommends that the government continue to use two-year planning horizons for the conduct of fiscal policy.

The government did more than make budgetary projections over a two-year period, however. It set targets to which it was committed and these targets became the benchmark against which the government's fiscal policy was judged. This practice brought transparency to government policy and imposed accountability on its actions. The fact that deficit targets were bettered every year earned the government a degree of credibility that had been lacking in the past.


"In our view, the Government of Canada's main priority must be to attain and maintain a balanced budget."

Mr. Manuel Dussault (Director of Research and Analysis, Alliance des manufacturiers et des exportateurs du Québec)


Having witnessed the value of deficit targets in restoring fiscal balance, the Committee favours their continued use in the new fiscal environment. What, however, should these new targets be?


"Now is the time to get our fiscal house in order and bring the debt down to a level where it or its carrying costs will never again threaten the economic health of our country. The time has come for true leadership... regarding our national fiscal policy. Leadership means facing the hard questions..."

Mr. John Maher (Lighthouse Family Resource Centre Inc.)


The targets which are chosen will largely determine how the fiscal dividend is allocated. For example, if the government's target is ever-increasing surpluses, then it is giving almost exclusive priority to debt reduction, since by definition a surplus represents a reduction in net debt. If, on the other hand, the government targets a balanced budget, it accords little importance to debt reduction since the level of net debt would remain constant over time. We wish to seek a balance between these two alternatives.


    RECOMMENDATIONS


  • The Committee recommends that the government establish a fiscal target of a balanced budget for 1998-99 and all subsequent years. As is the current practice, this target should include a $3 billion Contingency Reserve and should be based on prudent economic assumptions.
  • The Committee recommends that the government take steps to accelerate the downward trend in the net debt-to-GDP ratio and not rely solely upon growth in the economy. The unneeded portion of the Contingency Reserve should be applied to debt reduction.


``We must start paying down the debt so that it will be reduced for future taxpayers..."

Mr. Benoît Latulippe (Fédération des étudiants et étudiantes universitaires du Québec)


These recommendations would help ensure that the government need not run a deficit in future years. With the continued use of a Contingency Reserve, it means that the government must plan for an underlying surplus of $3 billion per year. In the absence of unforeseen events, the net debt would decline by at least $3 billion per year.


"I think we do need to have some explicit targets... (they) keep the government's feet to the fire. That's a good way to do it, because you do have something against which to measure the performance of the government...''

Mr. Josh Mendelsohn (Senior Vice-President and Chief Economist, Canadian Imperial Bank of Commerce)


Deficit reduction and balanced budgets are goals that lend themselves to short-term targets. A debt-to-GDP target is a longer-term goal.

We note that in 1985-86 the net debt amounted to about 50% of GDP and grew steadily for ten years, peaking at 74% of GDP. It was during this period that the damaging effects of fiscal excesses had the greatest impact.


    RECOMMENDATIONS


  • The Committee recommends that the federal government establish a long-term target for a sustainable debt-to-GDP ratio.
  • The Committee recommends that the federal government establish an interim debt-to-GDP target range of 50% to 60%, to be achieved in this mandate.

  • "In framing the upcoming budget we would ask the government to address those concerns in several ways, first by providing some clear framework around which Canadians can determine what level of continuing debt they might consider appropriate."

    Mr. Don McIver (Board of Trade, Metropolitan Toronto)


B. DEFINING CANADIAN PRIORITIES

1. Allocation of the Fiscal Dividend

The government has proposed that future fiscal dividends be allocated among three alternatives: enhanced program spending, tax relief and debt reduction, over the course of its mandate. Program spending is to account for 50% of the dividend, with the remaining half to be split between debt reduction and tax relief.


"We hear a great deal of talk these days about the fiscal dividend. Well, we don't have one yet. It is on the horizon, and I hope it will be used wisely when we reach that point."

Mr. Jimmie Gorman (Individual)


The Committee believes this to be a reasonable approach to the fiscal dividend's allocation. Program spending cuts accounted for the bulk of the government's restraint measures: about $6.90 in spending cuts for every dollar of revenue enhancement, and no increase in personal income tax. Indeed, program spending in 1996-97 was almost $18 billion less than its peak only four years earlier. As a proportion of GDP, it now amounts to just over 13%, and this ratio is still falling. Rarely in the post-war period have we seen such low levels of program spending in relation to the size of the economy.

This reduction in program spending stands in sharp contrast to the relative stability of budgetary revenues when measured against the size of the economy.

Moreover, the Committee has recommended that, once the deficit is eliminated, any unneeded portion of the Contingency Reserve be applied directly to debt reduction, much as it is currently applied to deficit reduction. As a result, we expect that the first $3 billion of future surpluses will be applied to debt reduction before any fiscal surplus is allocated to new spending or tax relief measures. This fact, coupled with reasonable expectations about future growth, should cause the net debt-to-GDP ratio to fall at an acceptable pace.

It is the restriction on the use of unneeded Contingency Reserve funds that gives debt reduction priority as a claim on the government's resources.


``Spending increases ... have to be focused on priorities, and there need to be clear objectives and accountability with respect to this. We don't want to get back into the situation where the government is throwing dollars at programs without some sense about what the benefit is going to be in doing this."

Mr. Robert O'Rourke (President, Simscape Development Corporation)


The Committee wishes to make clear that while we expect the government to have resources to spend in the near future, these should be spent with care, with a view to achieving measurable results and within a framework of accountability. New resources, whether they are invested through new programs or significant changes to existing programs, should be subject to some form of performance guidelines. These guidelines would spell out what the program intends to do and how its results will be measured. If it fails and cannot be improved, the program should be terminated.

But safeguards should be implemented before a new program is initiated. Program Review provides such safeguards and the Committee believes that all new initiatives must be rigorously put to the test of Program Review.


``We feel debt reduction should be a high priority ... Spending increases are necessary in some areas but should be carefully reviewed.''

Ms. Marie White (Acting Mayor, the city of St. John's)


Thus any new initiative must demonstrate that it is in the public interest by addressing an evident problem. If there is a problem, is it one that can best be resolved by government or would the private or voluntary sectors be more appropriate? If it is a problem for government, is the federal government the appropriate level to deal with the problem? And if so, what is the most effective and efficient way to deliver the program? Of course any new program must meet the test of affordability. While affordability is a necessary requirement, we must not presume that it is a sufficient basis for a new program.


" ...bringing the deficit down has also caused some inequities, and we should be looking to use some of this gain against some of these inequities."

Ms. Maureen Farrow (Loewen, Ondaatje, McCutcheon Ltd.)


``The progress made to date has not been without much pain and dislocation for many Canadians."

Mr. Thomas d'Aquino (President and CEO, Business Council on National Issues)


``While we're reducing that debt we also have to think about building a strong economy for Canadians and our Canadian people."

Mr. Francis Reid (General Manager, Construction Association of Prince Edward Island)


"We think that the debate now should focus on national priorities, on building a strong economy and a strong society.''

Mr. Richard Paton (President and CEO, Canadian Chemical Producers' Association)


The Committee wishes to stress that this review would not be an exercise in empire building but rather the implementation of a new set of checks and balances to ensure Canadian taxpayers get real value for their tax dollar, when it comes to new programs.

As noted earlier, the most challenging element of Canada's economic recovery has been the inability to substantially reduce the unemployment rate. There are a number of different facets to the problem of unemployment. For instance, the youth unemployment rate remains stubbornly high, and is considerably higher than the rate for the general population. We were told repeatedly that the lack of jobs is the principal cause of poverty. Disabled Canadians face daunting barriers to employment. Unemployment often amplifies the difficulties these and other vulnerable groups already face. Canadians told the Committee that addressing the problem of joblessness must be a national priority.

Thus new initiatives must reduce barriers to labour participation and promote greater labour market flexibility, as well as creating the environment in which jobs are created. New spending initiatives, therefore, should promote the government's growth and job creation agenda.

We therefore make the following recommendations.


    RECOMMENDATIONS


  • The Committee recommends that, over the course of the government's mandate, one half of future fiscal dividends be allocated to renewed and enhanced program spending measures, to meet the social and economic needs of Canadians.
  • The Committee recommends that any new spending initiatives be subject to the rigorous and detailed test of the principles of Program Review and that the results of that review be published at the time any new program is announced.
  • The Committee recommends that new spending initiatives be consistent with the government's jobs and growth agenda.
  • The Committee recommends that a gender analysis be conducted and published for new initiatives.

  • "For once, people are consulting one another to see what could be done with those surpluses. They have to be used in the most proper way and we should take our time to spend the money in those areas where it is most important for future generations."

    Mr. Bernard Côté (Organisation d'aide aux sans-emploi)


    "There will be many proposals, ideas, and contenders for increased spending in many areas of government responsibility. Of course, it is not going to be possible for all of those to be acted upon."

    Dr. John Hylton (Executive Director, Canadian Mental Health Association)


C. BUILDING A COMPETITIVE ECONOMY

1. High Technology and Higher Learning

A recurring theme heard by the Committee concerned the important role that the new economy could play in enhancing Canadian competitiveness, improving our health care, stemming the brain drain and providing new sources of financing for our institutions of higher learning.

1.1 Basic Research and Granting Councils

The common element in all of these is basic research. Basic research is both the starting point for all applied research and commercialization activities, and the fuel for Canada's innovation engine. The essential ingredient for basic research is government funding. The result is public-private partnerships to fund research, the introduction of entrepreneurial opportunities for universities and their researchers and the creation of employment opportunities for Canada's best and brightest students and workers. The government has already put in place the commercialization engine through programs such as the Networks of Centres of Excellence, Technology Partnerships Canada and the recently announced Canada Foundation for Innovation. Government initiatives have also led to the establishment of such innovative private organizations as the Canadian Medical Discovery Fund.


``This is a great example of a strategic investment of public funds and I use the word - strategic investment - with great care, I think these are words that should be precisely defined. In our case, I would say it means, to invest now in enable our young people to acquire the knowledge and skills to create wealth and produce prosperity for all Canadians in the future. Invest now to give them the skills so they will create wealth in the future."

Mr. Tom Brzustowski (President, Natural Science and Engineering Research Council of Canada)


How to adapt to the new and challenging economy that awaits Canadians is a major concern of the Minister of Finance and of the federal government. In his fiscal update, the third question assigned to the Committee for investigation was "...what is the best way that the government can help to ensure that there is a wide range of job opportunities in the new economy for all Canadians?" The Canadian Consortium for Research has put together an action agenda called "Sustaining Canada as an Innovative Society." According to that agenda, the first priority is to renew the research infrastructure in Canadian universities.

Despite recent initiatives such as the establishment of the Canada Foundation for Innovation and permanent funding for the Networks of Centres of Excellence, it must be noted that federal support for research as measured by funding to the Granting Councils has declined.

Funding for the Granting Councils has dropped throughout this decade. In 1998, real funding for the Medical Research Council, the National Sciences and Engineering Research Council (NSERC) and the Social Science and Humanities Research Council (SSHRC) will be lower than in 1985. This is particular damaging since the three councils support the majority of research performed at universities, teaching hospitals and affiliated research institutes across the country. In other words, it is these Granting Councils that assist in the financing of the day-to-day costs of basic research in Canada.


``...the three federal granting councils... are the gatekeepers of Canada's standard of excellence in scientific research."

Dr. Barry McLellan (Coalition for Biomedical and Health Research)


This funding trend is inconsistent with the government's stated intentions regarding research, and it is inconsistent with respect to other initiatives such as the establishment of the Canada Foundation for Innovation. The CFI is designed to finance the renewal of research infrastructure, in partnership with universities and the private sector. But new infrastructure will entail additional operating costs in the future, which cannot be financed by the CFI. In the absence of relatively secure operating finances, institutions might be reluctant to undertake new infrastructure initiatives. As a result, there is a possibility that the CFI may not be as effective as might otherwise be the case.


"Canada is going in the wrong direction compared to our competitors."

Dr. Barry McLellan (Coalition for Biomedical and Health Research)


This is even more worrying in light of fact that trends in other countries that are quite opposite to our own (see graphs at page 35). At the same time that MRC funding for 1998 will be below the 1985 level in real terms, the funding for the National Institute of Health in the United States will have increased by 80%. (The growth of funding for medical research in France and the United Kingdom resemble the American example more than the Canadian one.) And while funding for the American National Science Foundation will have increased by over 30% in real terms over the same period, combined funding for NSERC and SSHRC in Canada will have declined by almost 10%.

The Canadian Consortium for Research made a recommendation to the Committee that would see the funding of the Granting Councils grow by about 50% by the year 2001-02. Their budgets in that year would be $357 million (MRC), $651 million (NSERC), and $139 million (SSHRC).


"University research is one of the key engines driving the creation of knowledge."

Mr. Marc Renaud (President, Social Sciences and Humanities Research Council of Canada)


Research is an integral part of the learning experience offered by universities. It is part of the growth and wealth creation process of the new economy. And it provides exciting career opportunities for Canadian youth. It gives young Canadians the opportunity to obtain the best skills and knowledge and the incentive to put them to use in Canada.


"Since 1994, the faculty of medicine ...(of) the University of Manitoba, has lost 22 highly qualified, productive young scientists, together with their sharp minds, their training-this was paid for by Canadian taxpayers-and, more importantly, their patents and intellectual properties, primarily to the United States of America."

Dr. Garry B. Glavin (Associate Vice-President (Research), University of Manitoba)


"A well-educated and well-trained future generation is a long-term gain or asset for Canada."

Ms. Edith Perry (Individual)


The federal government is vitally concerned with the state of post-secondary education in Canada. It is also concerned with enhancing prospects for the new economy and stemming the brain drain. Funding research activity allows the government to target its resources to get the greatest impact from each dollar spent. For example, it is well known that the tax burden in Canada is higher than in the United States and that this results in some loss of skilled jobs to the U.S. But to address the problem through reduced taxes is extremely expensive. A better way is to fund initiatives that create research jobs directly. Similarly, the federal government could enhance its block grants to the provinces and assume that adequate amounts flow to educational institutions. A more effective method could be to channel funds directly through Granting Councils.

The Committee agrees with the tone and thrust of the presentation made by the Canadian Consortium for Research and other participants in the research and development roundtables.


"Canada needs a fresh stimulus to adapt to ... the new economy."

Mr. Pierre Franche (Executive Director, Canadian Academy of Engineering)


Canada needs a fresh stimulus to adapt to the new economy, which will be characterized by "haut savoir-faire", if we want to maintain and improve the economic well-being of our citizens. The three Granting Councils are the gatekeepers of Canada's standard of excellence in scientific research. They are the key to making Canada a leader in the modern knowledge-based economy of the 21st century.


    RECOMMENDATIONS


  • The Committee strongly recommends that the federal government make increasing funds available to the Granting Councils.
  • The Committee also recommends that the federal government make a commitment to long-term stable funding for the Granting Councils.


"Our competitiveness as a nation in future years will depend on our having up-to-date knowledge that's available only through basic research."

Mr. Donald Wells (President and Vice-Chancellor, University of Regina)


The Committee believes that this measure would be the most important action the federal government could take in the short term to boost long-term productivity, create jobs and help Canadians prepare for the economy of the future. We must invest now to give future generations the skills upon which this country will depend on to create wealth. It is a precondition for durable growth and job creation.


"Our message ... is very simple and that is that in order to grow, Canada needs investment. Our view is that investment in technology and investment in skills yields economic growth on a sustained basis."

Mr. Stephen Van Houten (President, Alliance of Manufacturers and Exporters' Association)


1.2 Investing in Innovation

In addition to investing in basic research, the government should invest in innovation by strengthening the ability of the private sector to transform knowledge developed in research laboratories into world-class products for global markets. During the Committee's consultations, there was support for creating increased targeted opportunities for knowledge transfer to small businesses and a favourable investment climate for stimulating growth sectors.

Developing a more innovative economy means improving Canada's capacity to turn knowledge into new products and services and bring them to market quickly. Witnesses noted the importance of responding to market forces in order to remain competitive. The government was urged to build on initiatives announced in recent budgets. Continued collaboration with the private sector will help government initiatives be responsive to the needs of the economy.


    RECOMMENDATIONS


  • The Committee recommends that the federal government make strategic, targeted interventions in high growth sectors where Canadian firms can become world leaders through funding from Technology Partnerships Canada.
  • The Committee recommends that the government improve the ability of the private sector, particularly SMEs, to transfer knowledge into world-class products for global markets through incremental funding for the Industrial Research Assistance Program.

1.3 Scientific Literacy


"Thanks to small seed grants from the federal government, we've been able to persuade the private sector, universities and foundations to become involved in elementary education. Specifically, with a total of about $100,000 from Industry Canada over the last four years, we've been able to leverage more than $2.25 million from the private sector."

Ms. Bonnie Schmidt (Let's Talk Science)


Once again this year, the Let's Talk Science organization appeared before the Committee. The group has put in place innovative programs designed to improve the level of science education in Canada. Scientists, technologists and engineers engage in activities that train teachers in science education, engage youth in science, encourage girls to develop an interest in science and promote informal science learning.

The Business and Education Forum on Science, Technology and Mathematics is another important private initiative, sponsored by several major Canadian corporations. This organization should act as a catalyst to engage business, educational and governmental organizations in helping young people to experience and embrace the excitement of science, technology and mathematics so that they can successfully contribute to, and enjoy, an innovative Canadian society. This new business-education partnership should greatly foster science literacy.


``An educated society leads to a healthier nation, so education of our youth is extremely important and pays off.''

Ms. Irene Dawson (President, Federation of Prince Edward Island Municipalities)


The Committee is encouraged by these initiatives. If successful they will increase the number of university science graduates. This should, in the long run, foster economic development and help create high skill/high wage job opportunities.


    RECOMMENDATION


  • The Committee recommends that the government find ways to foster innovative initiatives such as Let's Talk Science and the Business and Education Forum on Science, Technology and Mathematics, to nurture a research and science culture in Canada.

2. The New Information Highway Infrastructure Program


"It's not just bricks and mortar; it's education, health, training and communications."

Ms. Maureen Farrow (Loewen, Ondaatje, McCutcheon Ltd.)


The information highway is changing Canadian business and society. Private companies and individuals are building this new infrastructure and developing new applications. Given the depth of the changes underway, profound questions are being raised for government. Should it be a spectator in this process, or should government actively engage these new developments to ensure that the benefits are maximized and equitably distributed among Canadians?

While accepting private sector leadership, there is a significant role that the federal government can and should play. If we are to become a "knowledge-based" society, we must ensure broad access to new media. At modest cost, the federal government could build on the model of libraries and public telephones by expanding the successful Community Access Program to ensure that most Canadians have reasonable access to the information highway. We are already leaders in connecting schools with the SchoolNet program, which should be expanded to meet new needs. With this unique infrastructure and a critical mass of users in place, Canada could position itself to be among the countries that benefit most from the knowledge revolution.

A coordinated effort to create the best regulatory and legal environment for electronic commerce would help us to develop new exporting industries. Working with the private sector, we can ensure that our backbone networks are kept on the cutting edge through established, successful programs such as CANARIE. The environment resulting from these actions would provide a powerful inducement for the development of "content" industries, such as multimedia, tele-health and tele-learning. With sufficient investment capital in place, these sectors are poised to thrive.


    RECOMMENDATIONS


  • The Committee recommends that the government expand the SchoolNet program to ensure that all Canadian children have the opportunity to participate in the knowledge society.
  • The Committee recommends that the government expand the Community Access Program, in cooperation with private sector partners.
  • The Committee recommends that the government take a leadership role in establishing the worldwide legal and regulatory environment for electronic commerce.
  • The Committee recommends that the government keep Canada's networks leading-edge by continuing the CANARIE program, and ensure that sufficient investment capital is available to new Canadian industries developing new applications for the information highway.

D. BUILDING A STRONGER SOCIETY

1. Improving our Health Care System

Canada's health care system is a source of national pride. The fact that all Canadians, regardless of income or resources, have access to high quality medical care, without having to pay a fee, is identified as one of the most important factors in making Canada the best country in the world in which to live. It is also described as a characteristic which defines Canada as a compassionate society.


"The Council for Health Research believes that the committee has demonstrated an ongoing and strong interest in the health of Canadians and the integrity of our collective health research effort."

Ms. Audrey Vandewater (Executive Committee Member, Council for Health Research in Canada)


The Committee was told that, in recent years, Canadians have experienced new feelings regarding their health care system - concern about the quality of care, as well as fear about what the future may hold. Increasingly, Canadians are asking themselves if their much envied health care system will be there for them when they need it.

The fundamental problem is that the health care system that was put in place over 25 years ago was not designed to cope with such modern realities as diminishing financial resources, a growing and aging population, and rapid increases in the cost of medical technology. The system must adapt to these changing circumstances in order to continue providing quality health care to Canadians as we enter the 21st century.


"Canadians are looking for the federal government to play more of a leadership role."

Dr. John Hylton (Executive Director, Canadian Mental Health Association)


In recent years, the Government of Canada has taken steps to protect the integrity of the health care system, as well as to help prepare it for the challenges of the years ahead. The government has stated repeatedly that it is committed to protecting the five principles of the Canada Health Act (universality, accessibility, comprehensiveness, portability and public administration) and, on different occasions, has taken action to enforce compliance with the five principles.


"Atlantic Canadians believe in a strong federal government. We see that national standards in programs must be maintained, and these standards in many cases are more appropriately done or maintained federally."

Mr. Dave Neal (Fredericton Chamber of Commerce)


The government has also acted to foster the evolution and the transformation of the health care system. The National Forum on Health (NFH), a consultative body chaired by the Prime Minister, was launched in 1994. It was given the mandate to involve and inform Canadians and advise the federal government on innovative ways to improve Canada's health system and the health of Canada's people.

In 1997, the Forum presented its report. Among its conclusions were:

  • the health care system is fundamentally sound;
  • in Canada we spend enough money on health care;
  • however, the present structure (of the system) cannot accommodate speedy and drastic reductions in funding without compromising quality of care;
  • the non-medical determinants of health (e.g. gender, economic and social inequities, the environment, early childhood development, family structure, etc.) merit increased attention;
  • we need a more integrated system that funds the care, not the provider or the site.


In response to the National Forum on Health, the 1997 budget provided $300 million for additional health initiatives.

The government reacted favourably to the National Forum on Health report, and acted swiftly to put a number of its recommendations into practice. In response to the Forum's report, the 1997 budget provided $300 million over the next three years for additional health initiatives. Of that amount, $150 million will be allocated over three years through the Health Transition Fund. This Fund will provide the provinces with money for pilot projects designed to test ways of improving the health care system on the local level.

Another $50 million will be invested in the development of the Canada Health Information System, a coordinated national system of health information. In response to the Forum's call to address the plight of underprivileged children, $100 million will provide additional funding for two existing children's programs, the Community Action Program for Children and the Canada Prenatal Nutrition Program.

The government has continued to take action in response to the report of the National Forum on Health. In its most recent Throne Speech, the government pledged to:

  • support Canadians in responding to the growing need for home care and community care;
  • develop a national plan, timetable and a fiscal framework for providing Canadians with better access to medically necessary drugs;
  • deal with urgent health problems in Aboriginal communities;
  • establish an Aboriginal Health Institute.


"The CMA is pleased that the federal government has pledged to re-invest in health care. We are encouraged by measures introduced in recent federal budgets.''

Dr. Victor Dirnfeld (President, Canadian Medical Association)


The government also committed itself to expanding the Canadian breast cancer initiative, renewing the national HIV-AIDS strategy, and doubling the resources of the Tobacco Demand Reduction Strategy.

Finally, the government has stated that it will restore cash transfers under the Canada Health and Social Transfer (CHST) to $12.5 billion a year, another recommendation made by the National Forum on Health.


    RECOMMENDATIONS


  • The Committee applauds the government's initiative to increase the CHST cash floor to $12.5 billion per year.
  • We also recommend that the government consider establishing, in cooperation with the provinces, health care providers and local communities, new approaches to health care, such as a national home care system.

1.1 Anti-Smoking Measures

Another area directly related to health is the work being done on many levels to combat smoking. Smoking is the leading preventable cause of premature mortality in Canada. The most recent estimates suggest that more than 45,000 deaths annually in Canada are directly attributable to tobacco use.

The economic cost to society from tobacco use in Canada is estimated to be between $11 billion and $15 billion. Tobacco use directly costs the Canadian health care system $3 billion to $3.5 billion annually.

In the last three reports, the Committee recommended tax increases on tobacco products as much as possible without increasing smuggling. The last time the federal excise tax on cigarettes was increased was on November 28, 1996.


Almost 29% of young Canadians aged between 15 and 24 are smokers.

Increasing taxes on tobacco products is designed primarily to curb smoking, especially among the young, for whom price is often the most effective deterrent.


    RECOMMENDATION


  • The Committee endorses the government's decision to double the resources of the Tobacco Demand Reduction Strategy. The Committee further recommends that the excise tax on cigarettes be increased.

1.2 Supplementary Health Benefits

Another component of Canada's health care system is the network of supplementary health and dental benefits which benefit many Canadians. The Committee heard representations regarding the tax treatment of these plans. The possible taxation in the hands of employees of employer contributions to group health and dental plans is feared by many. The rationale for taxing these benefits would be to address the inequity between those who have supplementary health and dental protection and those who do not and therefore cannot benefit from the favourable tax treatment.

Two years ago, it was estimated that 3.6 million Canadians were not covered by supplementary private or public health and dental plans: 2 million Canadians to whom employers could have offered coverage under group plans but did not, 1 million unincorporated self-employed entrepreneurs and their dependents, whose health and dental coverage is not a deductible business expense, and 600,000 Canadians who are not employed, not eligible for special government plans and not covered as dependents under public or private plans. The 3.6 million figure is now lower because of the introduction of a universal drug insurance program in Quebec in 1997.


"The government's decision to support the provision of tax exempt and dental benefits to employees has proven to be among its most effective health measures."

Dr. Toby Gushue (President, Canadian Dental Association)


Enabling all Canadians to benefit from supplementary health and dental plans is a means of ensuring that everyone has equal access to the health care system. To begin to achieve this end, the government must recognize the changing nature of work. An increasing number of Canadians are self-employed or are working for SMEs which do not offer health and dental plans. This is why the Committee is making the following recommendations.


    RECOMMENDATIONS


  • The Committee recommends that unincorporated businesses be allowed to deduct the cost of supplementary health and dental coverage from income, to put them on the same footing as the incorporated self-employed.
  • The Committee further recommends that employees whose employers do not provide a supplementary health and dental plan be able to deduct, from income, the costs of acquiring adequate private coverage.

2. Helping Canadians with Disabilities

During this year's pre-budget consultations, many witnesses recognized the fact that the federal government had introduced important and effective measures to help disabled individuals.

Those measures were a response to past recommendations made by the Finance Committee and by the Federal Task Force on Disability Issues. The Task Force consulted with more than 2,000 Canadians and reported in October 1996 with over 50 recommendations. The key message was that living with a disability almost always entails additional costs and that the federal government should take action to address this issue. In last year's report, the Committee fully endorsed the recommendations.

The 1997 budget proposed measures to reduce the disability-related costs that stood in the way of full participation of Canadians with disabilities. Many of these were recommendations found in last year Committee's report. Among other measures, the list of expenses eligible for the medical expense tax credit will be broadened to include such things as: air conditioning for individuals coping with a chronic ailment (50% of the cost up to $1,000), the cost of an adapted van (20% up to $5,000), moving expenses to an accessible house, sign language interpreters fees, reasonable expenses to alter a driveway to facilitate access to a bus. The government also introduced measures to increase the limit on part-time attendant care expenses from $5,000 to $10,000. The $5,000 limit on the deduction for attendant care expenses for disabled earners will be eliminated.


"I think it's absolutely imperative that the federal government take a leadership role in establishing an initiative for a comprehensive and co-operative federal-provincial approach in the area of disability-related policy and programs."

Mr. Gary McPherson (Chairman, Premier's Council on the Status of Persons with Disabilities


Because Canadians with disabilities who enter the workforce often face additional costs and because they can lose important benefits provided by income security programs, the government has introduced a refundable credit for low-income working Canadians earning at least $2,500 and facing high medical expenses. The credit will provide supplementary assistance to the existing medical expense tax credit (the lesser of $500 or 25% of eligible expenses). This should help eliminate the welfare wall the disabled often face.

The government also announced the establishment of an Opportunity Fund for persons with disabilities. This three-year initiative should help develop strategies to reduce barriers to participation. A number of disabled Canadians could work part-time or full-time if they were provided assistance to prepare for, find and keep jobs.


"For Nova Scotians with disabilities the importance of federal participation and leadership in all of these areas is critical. The federal spending power must be used to ensure that an appropriate level of program equity exists across the country. "

Ms. Nita Irving (President, Nova Scotia Disabled Persons Commission)


The new tax measures for Canadians facing significant medical costs will increase the tax assistance by $70 million annually. The federal government will inject $30 million in the new Opportunity Fund.

These measures significantly increase the assistance announced in the 1996 budget when the government doubled the tax credit for those who provide in-home care for family members with disabilities. The Committee is encouraged by the measures announced in last year's budget.


    RECOMMENDATIONS


  • The Committee recommends that the government continue working with groups representing persons with disabilities to ensure that measures recently announced are effective, and to find further ways of helping Canadians with disabilities.
  • The Committee also recommends that the government consider extending the medical expenses tax credit to recognize the expenses incurred by parents of children with some learning disabilities.


``We know we have parents in crisis... Parents in some areas have had to pay for speech, occupational, and psychological therapy ...What these parents need is a disability tax credit to recognize that those expenses are legitimate."

Mr. James Horan (President, Learning Disabilities Association of Canada)


Such a measure would help parents who must invest in expensive materials as well as psycho-educational assessments, speech, occupational and psychological therapy. More importantly it would help children with a learning disability to become self-sufficient and productive members of our society.

3. Initiatives in Support of Children


``As the parent of a child who has learning disabilities, I can tell you that we live with this every day."

Mr. Roy Cooper (Learning Disabilities Association of Canada)


The federal government is extremely concerned about the well-being of children, especially those living in low-income families. The Committee was also deeply concerned when it heard that 900,000 children are in families that rely upon food banks.


``When you're looking at spending on children, you need to look at it as an investment, not as sunk money that doesn't have a return."

Mr. Mel Gill (Child Welfare League of Canada)


Children are among the most vulnerable members of our society. Canadian citizens have an obligation to protect our children. They are our future.

While there is no consensus as to how to measure child poverty, there is no controversy about the impact child poverty has on children's development. Studies tell us, that early intervention benefits brain development in the early stages of life. By not acting upon this knowledge we would be abdicating our responsibility to provide children with the opportunity to attain their full potential as active and productive members of our society. Investing in children simply makes good sense, on every level.


"At CAPC we have found that rigid rules and programming are a real barrier to those seeking help, support, and guidance. Instead, CAPC projects offer friendly, family-centred approaches that build on strength and address with respect whatever needs are identified and presented."

Ms. Joanna LaTulippe-Rochan (Coalition Member, Nova Scotia Association of Family Resource Projects)


Recent federal initiatives reflect this. The government announced $100 million in increased funding over the next three years for the Community Action Program for Children and the Canada Prenatal Nutrition Program. These programs fund community voluntary organizations across Canada that deliver services to address the development needs of young, at-risk children and address the problem of low birth weight babies among high-risk groups.

The government has also improved the child support system to ensure that custodial parents and their children receive the financial support they are entitled to and need.


"We urge the federal government to continue to demonstrate leadership in this area and build on the past collaborative successes, such as community action programs for children."

Dr. Graham Chance (Canadian Institute of Child Health)


Thanks to recent initiatives taken by the federal government, particularly an infusion of $850 million into the Child Tax Benefit, a national agenda for children is now developing. It involves a partnership that goes beyond the federal and provincial governments. It includes the important voluntary and non-governmental sectors as well. Together, these partners should be able to develop a plan ensuring that every child in this country will have an equal opportunity of becoming healthy, educated, self-sufficient and productive.

The Canadian Living Foundation proposed one such partnership in its fight against hunger. Through its Breakfast for Learning Program, the foundation has assisted communities in establishing over 1,800 nutrition programs and serving more than 22 million meals to children since its inception in 1992.

Federal, provincial and territorial governments are working together to build a National Child Benefit System. Discussions have progressed to the point where there is broad agreement on an approach for developing such a system.


"I think we can probably agree that the largest single problem we have now in Canada is the problem of children in poverty, particularly in single-parent families."

Mr. Paul McCrossan (Eckler Partners Ltd.)


This new Child Benefit System will address the problems low-income families with children face under the current regime. Right now, the combined effect of federal and provincial programs is to reduce a variety of child benefits for parents who leave welfare to enter the workforce which, for a two-child family, can represent a loss of $3,000 or more. They also lose a variety of in-kind benefits such as prescription drug and dental benefits. And their income is subject to tax (income taxes, CPP/QPP, EI premiums). Social assistance recipients are not subject to such taxes. Moreover, working parents face employment-related expenses as well as childcare.


"We can't invest in children without also supporting and investing in their parents, especially mothers."

Ms. Stella Lord (Researcher, Nova Scotia Advisory Council on the Status of Women)


We were told repeatedly that the answer to child poverty is jobs for their parents, yet the design of our social programs penalizes disadvantaged children when their parents have a job. Families with three children and net income of $21,000 will typically take home less than forty cents on each extra dollar earned, a marginal tax rate higher than that imposed on the wealthiest of Canadians. It is little wonder that many people find it very difficult to leave the welfare rolls.


"To get to independence, the way things are now, that first rung is a little rickety, and I hate to say this, but welfare and EI make a lot more sense than many jobs... If you work, you should not be poor."

Mr. Ian McDonald (Mayor of Charlottetown)


The Working Income Supplement component of the current Child Tax Benefit is intended to mitigate this perverse situation, but does so only partially. Thus the federal government has decided to be a leader in harmonizing federal and provincial income support measures to successfully combat child poverty, and in designing a fairer system that would not act as a disincentive for poor families to leave social assistance. Starting in July 1998, under the new National Child Benefit System, low-income families will benefit from a simplified and more effective income support system. The new regime should help reduce the depth of child poverty in low-income working families and promote attachment to the workforce.


The federal government already provides over $5 billion in Child Tax Benefits and this total will grow to almost $7 billion per year as a result of measures already announced.

In order to finance the proposed Canada Child Tax Benefit, the Government of Canada will combine the existing $5.1 billion allocated to the Child Tax Benefit and the Working Income Supplement, with the $250 million committed in the 1996 budget and the $600 million announced in the 1997 budget for the Working Income Supplement. The government recently announced that it would invest an additional $850 million when fiscal circumstances permit. The provinces have committed to redirect an amount, comparable to that of federal assistance, in income support and children's services for low-income working families. Working together, the two levels of government should be able to provide a stronger income platform for poor families.

As an interim step the government has already announced in its last budget that the Working Income Supplement will be increased from $500 per family to $605 for the first child, $405 for the second and $330 for each additional child. A low-income working family with one child will see the annual benefit (CTB plus WIS) rise to $1,625. Low-income families with two children under seven should receive up to $3,476 once the new Canada Child Tax Benefit is in place.

The Committee is encouraged by all these initiatives. If successful, they will soon offer a better future to hundreds of thousands of children. Other measures such as increasing the value of the basic personal exemption and the married exemption will help increase the disposable income of low-income families.


    RECOMMENDATIONS


  • The Committee recognizes the initiatives of the federal government to date and recommends additional resources be dedicated toward helping poor children as the fiscal dividend grows.
  • The Committee further recommends that the federal government partner with communities, parents, provincial governments, private corporations, the agri-food industry and voluntary organizations such as the Canadian Living Foundation to create a national school nutrition program. This type of partnership approach could apply to other organizations and initiatives as well.

  • ``70% of Canadians believe that child hunger in Canada is more important than national unity or the deficit."

    Ms. Martha O'Connor (Executive Director, Canadian Living Foundation)



``Strategic investment in a national school nutrition program is an investment in the future of all Canadians."

Ms. Martha O'Connor (Executive Director, Canadian Living Foundation)


We believe these initiatives will ensure a better future for Canada's children and help to provide better opportunities for poor children to fully participate in the Canadian economy and society.

4. Creating Opportunities for Canada's Youth


The Youth Employment Strategy will help over 127,000 young people.

In response to the findings and recommendations of the Ministerial Task Force on Youth (1996), the federal government implemented the Youth Employment Strategy earlier this year. It is an action plan that builds on federal initiatives already in place for young people.

One of the keys to the success of Canada's Youth Employment Strategy is that it does not attempt a "one-size-fits-all" approach to programming. For example, compare a youth living on the street to a university graduate who just cannot secure that all important first job. Both are unemployed, but they need different kinds of support to get them back on track.

4.1 Tangible Work Experience


Studies indicate that 45% of new jobs created between 1990 and 2000 will require more than 16 years of education and training.

One fifth of young Canadians have never had a job. Lack of work experience is a major stumbling block for most Canadian youth. The government introduced a number of measures, in 1994, to give young Canadians the opportunity to gain valuable work experience and develop job-related skills.

The Youth Internship program has proven overwhelmingly successful. Over two thirds of internship participants find jobs within six months of completing the program, many with the company or organization with whom they interned.

The Youth Employment Strategy builds upon that success by expanding internship opportunities. Internship programs will be established in partnership with the private sector and community organizations, in growth industries such as science and technology, the environment, international trade and international development.

Student Summer Job Action is another successful youth employment program. It features 14 initiatives designed to create summer employment opportunities for secondary and post-secondary students, including: Human Resource Centres for Students, Summer Career Placements and Student Business Loans, to name a few. These initiatives will help over 127,000 students by the end of next year.


    RECOMMENDATION


  • The Committee recommends that the government continue to invest in youth and increase the current level of funding of the Youth Employment Strategy.

4.2 Youth-at-Risk


"If there is one group which should be made a priority, it is our young people."

Mr. Bernard Côté (Organisation d'aide aux sans-emploi)


The Committee heard from expert after expert about the new economy and the changing world of work. We know that tangible skills and knowledge are the essential tools in the new economy. Education and training are essential, and yet there is a segment of Canada's youth who cannot even access the basic necessities of life, let alone higher education. High school drop-outs, many Aboriginal youth, single mothers and street kids, these are Canada's youth-at-risk.

Studies indicate that 45% of new jobs created between 1990 and 2000 will require more than 16 years of education and training. Yet 37% of on-reserve youth have less than a grade nine education.

These youth deserve the same opportunities as other Canadian youth, to look at the future with optimism, to hope, to dream and to accomplish. That being said, youth-at-risk face a daunting task, breaking the cycle of dependency, securing their first job and getting started on their career path.

Their needs are almost without limit: encouragement, mentorship, child care, communications and leadership skills, basic education, work experience and self-confidence. The fact is, standard work experience programs do not do enough to address these needs. Programs that focus on life skills, like leadership and communication, can provide these youths with the fundamental skills many Canadians take for granted. Youth Service Canada has continuously given at-risk-youth the help they need to succeed in the new economy.


    RECOMMENDATION


  • The Committee fully endorses the recommendation made by the Ministerial Task Force on Youth (1996) " that youth-at-risk be given a high priority as the government, and its partners, develop new strategies to create opportunity for Canadian youth. " Hence, the Committee recommends that additional funding be made available for Youth Service Canada and Student Summer Job Action.

5. Debt Relief for Post-Secondary Students


"The volume of debt that graduates are carrying right now has jumped to $25,000 this year, from around $8,000 in 1990."

Ms. Jennifer Story (National Deputy Chairperson, Canadian Federation of Students)


The Committee heard from student groups and others who noted that many university students are graduating with unprecedented debt loads now that they are expected to pay more of the costs of post-secondary education. We were told, for example, that students would be graduating in 1998 with an average debt of about $25,000.


For students who graduated in 1990-91, the average default rate on their student loans is 23%.

While it is generally accepted that students should bear a fair share of the costs of their education, since it represents one of the best investments they could make, governments at all levels are also concerned about ensuring open access to institutions of higher learning. Students should not be barred just because they come from families with modest incomes.


"The federal government can be a lot of things to a lot of people. Its student loans program, ... enabled me to get an education, and for that I'm grateful."

Mr. Ian McDonald (Mayor of Charlottetown)


The federal government undertook a number of initiatives in this regard in the 1997 budget. It doubled to $4,000 the annual contribution limits for investments in Registered Education Savings Plans and made the plans more flexible, thus reducing the risks associated with their use. Funds in a wound-up RESP can now be rolled over into an RRSP, for example. The 1997 budget also increased the value of the education credit, included mandatory ancillary fees as part of the tuition credit and allowed the unused portion of the credits to be carried forward. It also allowed graduates facing hardship to defer repayments on their student loans for up to 30 months after the end of the six-month grace period after graduation. The federal government pays interest on loans during this period. This interest subsidy costs the federal government about $200 million per year.


The 1997 budget announced higher tax assistance for students and their parents. As well, graduates will have up to 30 months to begin paying their Canada student loans.

The changes announced in the 1996 and 1997 budgets will have increased the education credit from $80 per month in 1995 to $200 per month in 1998. The amounts of the education and tuition credit that may be transferred from students to parents has been raised from $4,000 to $5,000.

The Committee believes that there is no better place to invest the fiscal dividend than in our future. We have spent too long paying for the over-consumption of the past. It is now time to invest in Canadians and in a strong and productive economy.

To that end, we think that a further modification to the RESP could help to make it a better instrument for building up student finances. It was suggested to the Committee that the RESP be treated like RRSPs and thus allow taxpayers to deduct from income their annual contributions. We reject this because of its cost and because the benefit accrues to the contributor at the time of the contribution, not to the student at the time of study. Instead we suggest that the federal government match a small portion of contributions to RESPs by offering a "top-up" to the student beneficiaries of these plans during their post-secondary education. If, for example, a parent contributes $2,000 per year into an RESP for a ten-year period, a 10% federal top-up on contributions would entitle the beneficiary to a $2,000 grant towards the cost of post-secondary education. This grant would not be available to parents who use the RESP proceeds for other purposes such as financing their own training or rolling it over into an RRSP.


    RECOMMENDATION


  • The Committee recommends that the federal government establish a deferred credit formula for the RESP that would offer student beneficiaries a federal grant, calculated as a percentage of total RESP contributions. This grant would be disbursed in equal amounts in each year of a recognized post-secondary program.


"Student loans are very important. I have two children in university now, and one is not sure he wants to go to university... When they get out of university they are going to have one great big loan to pay back - never mind a home or plans for a home. There need to be more bursary types of write-off."

Ms. Edith Perry (Individual)


The Committee believes the federal government should do more to help alleviate the debt burden of students. The federal and provincial governments offer student loan programs, and students' debt result from a combination of the two programs.

Better measures to assist students require an accurate assessment of the situation in which they find themselves. Loan maximums must reflect the cost of education and the likelihood of being able to supplement assistance with employment earnings. The special case of part-time students and those with family responsibilities must also be taken into account. Loan programs should not distort their incentives to continue working and schooling.


"It would be unconscionable if post-secondary education in this country became accessible only to those from affluent backgrounds."

Mr. Gerald Brown (President and CEO, Association of Canadian Community Colleges)


Once a debt is accumulated, the loans program should be designed so that it does not impose an excessive burden on students. Thus the Committee supports enhanced federal measures to alleviate student debt and make repayment easier. We therefore support a repayment schedule based on income. But we believe the government should go one step further and provide some degree of debt relief. As suggested by the Canadian Alliance of Student Associations, this debt relief should be needs-based and take into account the financial situation of graduates and their ability to make the transition into the job market. The Committee is also concerned about the barriers faced by students from low and modest income families who may wish to pursue post-secondary education. Just the possibility of high future debt loads keeps many of these students out of post-secondary institutions. We believe the student loans program should help those students. Thus we make the following recommendation.


    RECOMMENDATION


  • The Committee recommends that the federal government, in cooperation with the provinces and territories, offer students a debt repayment schedule that is based upon income, with features that may include interest relief, deferred grants and debt forgiveness.

E. BUILDING A FAIRER TAX SYSTEM: The Basic Choices

As the Committee noted above, one-half of the future fiscal dividend is to go to debt and tax reduction. While debt reduction is a straightforward concept, tax reduction presents a variety of options to the government, depending largely upon what the government wishes to achieve from tax reductions.


``The APFF feels that it would be premature to immediately substantially reduce the tax burden on taxpayers before all governments in Canada start finding stable budget surpluses."

Mr. Yvon Caron (Association de planification fiscale et financière)


Most Canadians would agree that our total tax burden is higher than they would like it to be. In his Economic and Fiscal Update, the Minister of Finance stated that "the tax burden in Canada must be reduced. It will be reduced." However, he added that, "...until the (fiscal) dividend is large enough to safely support a meaningful reduction in the overall tax burden, the most responsible course is to bring in targeted tax relief where the need is greatest."


``Canadians are not asking for tax cuts."

Ms. Christa Freiler (Child Poverty Action Group)


Witnesses appearing before the Committee generally endorsed the approach recommended by the Minister. Except for the Canadian Taxpayers Federation, no witness argued in favour of across-the-board tax cuts. With the exception of Employment Insurance premium reductions, which constitute a special case and which we will discuss later, no witness argued in favour of immediate and broad tax cuts.


"Our position on the BCNI has not been to support the idea of immediate, up-front tax cuts... First, we want to see convincing progress on debt reduction."

Mr. Thomas d'Aquino (President and CEO, Business Council on National Issues)


Instead, witnesses argued that the federal government should start reducing taxes only when affordable, i.e. when the fiscal dividend is significantly large and when the budgetary gains we have so far achieved are on more solid ground. In the view of the majority of witnesses, the number one priority should be debt reduction. There was almost unanimous recognition that expensive across-the-board tax cuts could jeopardize our fiscal gains and return us to a vicious fiscal cycle. The Committee agrees with this observation.

The government is certainly committed to rewarding hardworking Canadian taxpayers, who have all sacrificed so much over the past few years. But this Committee cannot recommend that a responsible government reduce the overall tax burden by cutting taxes across-the-board.


"We applaud the Finance Minister's acknowledgement in his October 15, 1997, presentation that a major tax reduction at this juncture would not make any sense."

Mr. Dan Overall (Director, Policy and Communications, Manitoba Chamber of Commerce)


First, we simply cannot afford it at this time. For example, reducing each of the three marginal tax rates by 1 percentage point would cost the treasury $3.25 billion. To eliminate both federal surtaxes would cost the government at least $2.5 billion. The 1998 budget is unlikely to have this much room to manoeuvre.


``Canada is on the right fiscal track, that our government needs to remain prudent and responsible in its budgetary policies."

Mr. Don Goodison (Certified General Accountants' Association of Canada, Partner, Kemp Harvey Goodison, Certified General Accountants)


Second, in the context of a small fiscal dividend, reducing budgetary tax revenues, without any matching reduction in expenditures, could damage our improved fiscal situation and our ability to reduce our huge debt load. Only recently have debt servicing costs fallen. Now is not the time to redirect more money to interest payments. Now is the time to make efforts to help the most vulnerable in society.

Third, considering the large debt burden, it is too risky. Future economic conditions (such as a rise in interest rates or an economic slowdown) and the unpredictable nature of political events could seriously erode the small fiscal dividend we expect in the next few years. We know that a 1% increase in interest rates would cause the deficit to increase by $1 billion in the first year. As longer-term debt matures and is refinanced at the higher interest rates, the deficit in year four would be $2.6 billion higher. Eroding tax revenues at this time is premature.


"On the other hand, tax cuts will deprive the federal government of the revenue needed to make social investments in children and families, and tax cuts will increase the likelihood that social spending cuts will be seen to be necessary the next time Canada experiences a serious recession."

Ms. Christa Freiler (Child Poverty Action Group)


Fourth, Canada's tax regime is not completely out of line vis-à-vis other industrial countries. Taxes raised by all level of governments in Canada equalled 37.2% of GDP in 1995 (see the table below). The average for the OECD member countries was 37.4% of GDP, while it was 36.6% for the G-7 nations. The United States and Japan imposed significantly lower taxes, while Italy, France and Germany imposed higher taxes. Britain's taxes were modestly lower than Canada's as a percentage of GDP. Thus Canada was in the middle rank of the G-7 nations.

It is true that Canada relies more on the personal income tax than other countries. These taxes represented 13.9% of GDP in Canada versus an average of 9.6% for G-7 nations. This difference can be explained by the fact that the overall payroll tax burden in Canada is relatively low when compared to France, Germany, Japan and Italy.


"We recognize that it's not easy to implement large tax reductions at this point...but that there will be real tax reductions in the future as the fiscal situation stabilizes and improves."

Mr. John Hansen (Chief Economist and Assistant Managing Director, Vancouver Board of Trade)


Tax Revenues as a percentage of GDP, 1995

Canada

United States

Japan

France

Ger many

Italy

United King dom

Personal
Income Tax
13.9 10.1 6.1 6.2 10.7 10.8 9.7
Payroll Taxes 6.2 7 10.4 20.4 15.4 13.2 6.3
Corporate
Income Tax
3 2.6 4.3 1.6 1.1 3.6 3.3
Sales and
Excise Taxes
9.5 5 4.3 12.2 10.9 11.3 12.3
Property Taxes 3.9 3.1 3.3 2.3 1.1 2.3 3.7
Other 0.5 0.1 1.8 0.1
Total

37.2

27.9

28.5

44.5

39.2

41.3

35.3

Source: Revenue Statistics 1995-1996 of OECD Countries (Paris, OECD, 1997)

When compared to the United States, our most important trading partner, Canada's overall tax burden is high; Canadian personal, sales and excise, and property tax burdens are significantly higher, while corporate taxes are comparable and our payroll taxes are lower. On many occasions the Committee heard from witnesses that personal income taxes, especially for high income earners, are a significant deterrent to attracting and keeping highly-skilled executives and professionals. The high personal income tax burden was also raised as one of the variables that explained why entrepreneurs and executives are tempted to move to the United States, as well as the brain drain that lures some Canadian scientists, computer experts and other highly paid professionals to other jurisdictions.


"We must ensure that our tax system is competitive when it comes to attracting and retaining investment. If it isn't competitive, the companies won't come. Today companies can locate their operations any place around the world.''

Mr. Stephen Van Houten (President, Alliance of Manufacturers and Exporters' Association)


The Committee recognizes that increasing international competition resulting from trade liberalization (e.g. NAFTA) and the rapid growth in low-wage countries may increase pressure to reform our tax system. Income tax rates in the United States will remain low and proposed reductions to capital gains taxation could put renewed pressure on Canada to follow suit.


``In our view the EI issue is really secondary to the personal income tax issue. The real benefits to Canadians, broadly, will be through a reduction in personal income tax."

Mr. Thomas d'Aquino (President and CEO, Business Council on National Issues)


The Committee cannot, however, recommend extensive personal income tax cuts at this time. As the fiscal dividend increases and as the federal fiscal position solidifies, the Committee believes the government should first consider reducing personal income taxes for low to moderate income families.

Patience is a virtue. By waiting a little bit longer, we will be able to offer larger tax cuts down the road. In other words, resisting the temptation to cut taxes now can be seen as an investment in bigger tax cuts later, as well as greater room to manoeuvre on the part of the government. The Committee shares the view of many witnesses who argued that the government should significantly reduce the overall tax burden of Canadians only when we will be able to afford it.


"We're not advocating a tax break prematurely. We're advocating it in terms of a balanced budget situation..."

Mr. Walter Robinson (Federal Director, Canadian Taxpayers Federation)



    RECOMMENDATION


  • The Committee is opposed to across-the-board tax cuts for the time being. It recommends that such cuts, both at the personal and corporate level, be considered only when circumstances allow, with personal income tax cuts taking priority over corporate tax cuts.


"Tax cuts must not be across the board."

Mr. Dave Neal (Fredericton Chamber of Commerce)



``A fairly strong consensus that the people of Alberta in general don't want to see tax cuts."

Mr. Jim Selby (Research Director, Alberta Federation of Labour)


Before significantly reducing the overall tax burden, we must reinvest in society and direct our investment toward those who are the most vulnerable. The most responsible course is to bring in targeted tax relief where the need is greatest. Those Canadians who have suffered the most over the past 4 years need our help. The government has already taken a number of important tax initiatives. The 1997 budget provides for almost $2 billion in selective tax cuts over three years. The main beneficiaries will be low-income families, charities, the disabled, students, workers and parents saving for their children's future education. As the fiscal dividend grows, the government will be able to introduce additional targeted tax measures.


"I congratulate Canadians for the pain they put up with to get the deficit where it is... I think Canadians have really done the suffering. There may be some equity things we need to address."

Ms. Maureen Farrow (Loewen, Ondaatje, McCutcheon Ltd.)



    RECOMMENDATION


  • The Committee recommends that the government introduce new targeted tax measures to help those in greatest need.


"We stand by our call for a tax cut, that we agree that a broadly-based cut can wait until a surplus is firmly established. What we need now is a targeted tax cut ... for low income Canadians."

Mr. Don Goodison (Certified General Accountants' Association of Canada; Partner, Kemp Harvey Goodison, Certified General Accountants)


1. Taxes, Inflation and Modest Income Families

1.1 Indexation

As a result of persistent high inflation, the 1973 federal budget introduced inflation indexation into the personal income tax system. The thresholds for the various income tax brackets as well as the value of exemptions and deductions were to change automatically in response to inflation. The same indexation rules came to be applied to a variety of transfer programs as well.


``We should recognize that taxes are still being increased on an annual basis. I'm sure that we in this room are all aware of the fact that the tax system is not indexed; the credits for children, the child tax benefit, is not fully indexed to inflation; the GST credit, which protects low-income families from the regressive GST tax, is not indexed to inflation; the disability credit is not indexed to inflation; and all the income tax brackets are not indexed to inflation."

Mr. Richard Shillington (Research Associate, Canadian Council for International Cooperation)


The 1985 budget modified the indexation rule to take into account only inflation in excess of 3% per year. Certain social transfers were also made subject to this modified indexation system. This "CPI minus 3" rule continues to apply today.

Since the federal tax system has been subject to partial indexation for over a decade, there has been a dramatic impact on taxes and social transfers. The Committee estimates that as of 1995, partial indexation added over 840,000 low-income families to the income tax rolls.

A tax system not indexed against inflation has three notable effects, all of which work to increase government revenues: it increases the tax base, it increases the average rate of tax that is applied to the tax base and it raises the marginal tax rate that individuals face with respect to employment and investment income.

The first effect of de-indexation is to cause taxable income to grow at a faster pace than total income. This occurs because exemptions and credits, such as the basic personal exemption and the spousal exemption, decline in real value. As a consequence, households become subject to income tax at lower levels of real income. Low-income families, whose income merely keeps pace with inflation, will eventually be subject to income tax, solely because of inflation and thus will suffer a decline in their standards of living. Those who were already paying taxes will see a larger proportion of their total income subject to tax because of the reduced real value of these exemptions.


"The failure to index personal income tax at inflation rates less than 3% has been a major source of revenue. I think that's been barely tolerable,... but because I attach a very high value to an honest and transparent tax system, it's not a measure I feel very comfortable with."

Mr. David Laidler (Department of Economics, University of Western Ontario)


With de-indexation, the nominal values of the tax bracket thresholds remain constant, while declining in real terms. This is known as bracket creep and is a feature of a progressive tax system. It leads to two other effects. It increases the average rate of tax that is applied to the taxable income base. It also increases the marginal tax rate that applies to workers incomes and investors returns. This last effect does not apply to those in the highest tax bracket.

We believe that some of the negative effects of the current system should be offset and hence we make the following recommendations.


    RECOMMENDATIONS


  • The federal government should increase the basic personal non-refundable tax credits amount, the spousal amount and the equivalent-to-spousal amount for the 1998 taxation year.
  • In addition, we go a step further and recommend thatthe government re-introduce indexation when the fiscal situation permits.

1.2 Surtax


To increase both the basic personal exemption and the married/equivalent exemption by $100 would cost the government about $300 million.

The previous government not only modified indexation of the personal income tax, it also introduced a temporary surtax in order to finance its own fiscal restraint measures. This surtax was originally a high income surtax but it eventually comprised two parts, a high-income surtax of 5% and a general surtax of 3%. Both are applied not to income, but to basic federal tax.

As with the modified indexation system, these surtaxes represent an aberration of the tax system as it was intended. The marginal tax rates, including the lowest one, are higher than they were designed to be.

The Committee believes that these taxes distort the structure of the personal income tax from what was intended. Hence we believe they should be removed. Full removal would cost about $2.5 billion. In the interim, the government should gradually phase out the surtaxes, starting with the initial general tax so as to again concentrate the benefits on modest and middle-income taxpayers. A one percentage point reduction in the general surtax would cost the government about $660 million.


    RECOMMENDATIONS


  • The Committee recommends that the government announce a schedule for removing the temporary surtaxes.
  • The Committee recommends that the 3% surtax be reduced for 1998.

2. Employment Insurance


The recently announced 20¢ EI premium reduction will save employers and employees $1.4 billion each year.

Employment Insurance is the only payroll tax at the federal level and it constitutes government revenue. The federal government and the provinces also jointly impose a mandatory Canada Pension Plan contribution on employees and employers. Provincial governments impose their own set of payroll taxes to finance health services, welfare and programs to deal with high unemployment, for example.

The general consensus among witnesses was that the changes to the CPP were necessary and welcome. However, many witnesses argued that the increase in CPP premiums should be balanced by reduced EI premiums. They first argue that high EI premiums are silent killers of jobs. Second, they believe the large surplus in the Employment Insurance Account is not justified.

2.1 Employment Insurance Premiums


"I think it's simply wrong to argue that EI contributions are a job killer. I believe there is no evidence for that across the board."

Mr. David Laidler (Department of Economics, University of Western Ontario)


There is very little statistical evidence that high EI premiums significantly discourage employers from hiring new workers. What the evidence shows is that in the long run, payroll taxes are largely, if not totally, shifted to employees and consumers. Hence, the long-term employment effect is not much different from corporate taxes or consumption taxes. It is in the short run, however, that increasing EI premiums may have the reverse effect, since they increase the costs of labour by the full amount of the employer's contribution. As a result, employers may choose to reduce employment to cut costs. It is for this reason that this government has substantially reduced EI premiums since 1993 and has insured that rates will not rise during any future period of higher unemployment.

  • The three-year statutory average formula established in 1971 would have required the employee premium to be set at $3.30 per $100 of insurable earnings for 1995. Instead, the Minister of Finance set it at $3.00. The overall benefit to employees and employers was $1.9 billion.
  • The rate for 1996 was reduced to $2.95, a further benefit of $350 million.
  • The rate for 1997 was reduced to $2.90, a benefit of $350 million.
  • Maximum insurable earnings were reduced from $875 to $750 a week, a benefit of $900 million
  • Premium relief of $5,000 was announced in December 1995 for businesses that paid less than $30,000 in employer premiums, a benefit of $150 million over two years.
  • For 1997 and 1998, the government will provide businesses that pay less than $60,000 in EI premiums with an enhanced refund of up to $10,000 based on the difference between premiums payments in those two years and payments in 1996. The overall benefit of this is estimated at $315 million.

In total, this government has already cut EI premiums by $4 billion. This does not mean that the EI premium rate should not be further reduced. There is no doubt that it will come down over time.


``The EI premium rate, it is extremely expensive to offset the CPP increases and it may not be feasible."

Mr. Rick Eggleton (Deputy Chief Economist, Bank of Montreal)


Nonetheless, some witnesses recommended that the EI premiums be reduced from $2.90 to $2.00 per $100 of insurable earning. Not only would this cost the government almost $6.3 billion in lost revenues, it would also be below the actuarial break-even rate. In addition, any significant reduction in EI premiums at this time would put our extraordinary budgetary achievements at risk. Unless the government increases other taxes or further reduces program spending, the government cannot reduce EI premiums by a large amount without having a negative impact on the overall budget. A significant EI premium rate reduction would likely eliminate any chance of balancing next year's budget. In addition, this Committee believes that the deterioration of Canada's fiscal health would be more damaging than the maintenance of EI premiums at current rates. If payroll taxes are silent killers of jobs, so is a deteriorating fiscal situation. The successful fiscal measures have paid off in lower interest rates and in creating more jobs for Canadians. This is why, as a responsible Committee, we cannot recommend costly decreases in EI premiums.


"With respect to the EI ... it is expensive, and we should only do it when we can do it. ...and if we reduced it (the surplus in the EI fund) sharply we'd have a deficit again."

Mr. Josh Mendelsohn (Senior Vice-President and Chief Economist, Canadian Imperial Bank of Commerce)



  • RECOMMENDATIONS


    As this report was in its final stages of preparation, the Minister of Finance announced that EI premiums for 1998 would be $2.70 per $100 of insurable earnings, 20 cents below the 1997 rate. This measure will result in a $1.4 billion saving for employers and employees.

  • We support this initiative completely. It is in accord with what we heard from witnesses and with our own analysis of the situation. The premiums should be further reduced when the fiscal situation permits.

A variety of witnesses, most notably the Canadian Federation of Independent Business, expressed their satisfaction with the New Hires program and their wish to see it continue.

2.2 Surplus in the Employment Insurance Account

The rationale for the size the accumulated surplus in the EI account is that the government wishes to ensure that payroll taxes are not increased during recessionary periods. Many of us remember when the previous government was forced to increase premium rates just as the economy was contracting. For example, in 1989, UI premiums went from $2.35 to $1.95 while from 1990 to 1994 they were gradually increased from $2.25 to $3.07, creating high payroll costs just when they were least opportune. In 1993, the deficit in the EI account was almost $6 billion.

The current government decided that the perverse cyclical pattern of EI premiums should be a thing of the past. Hence, in 1995, it announced that a sustainable surplus would be accumulated to mitigate employment insurance premium rate increases during periods of slow economic growth. Because of this cushion, EI premiums will not have to be increased during the next recession, precisely when jobs are most scarce and businesses are least able to bear the added cost.


In 1993, the deficit in the EI account was almost $6 billion.

The amount of reserves needed to ensure relative premium rate stability is not some fixed amount. The 1996-97 surplus in the EI account was less than $6.5 billion. Many witnesses argued that this amount is more than sufficient to cover any future liability in the premium rate. Hence they asked that the Committee recommend a significant reduction in EI premiums. On the other hand, the chief actuary believes that a $15 billion accumulated surplus is sufficient to meet the government's goal.

The Committee fully endorses the concept of a prudent surplus in the EI account. Thus we make the following recommendation.


    RECOMMENDATION


  • The Committee recommends that the federal government take the measures necessary to ensure that EI premiums not be increased during an economic downturn.

3. The Retirement Income System

3.1 The Three Pillars


A 9.9% contribution rate ensures that the CPP remains affordable for Canadians now and in the future.

Pillar 1 (Old Age Security (OAS) and Guaranteed Income Supplement (GIS)) provides a minimum level of retirement income. The government will replace the OAS and GIS in 2001 with a new Seniors Benefit. Benefits to low-income Canadians will be increased, while assistance to high-income earners will be considerably reduced. The government should soon introduce legislation enacting the proposed changes.

Pillar 2 (CPP/QPP) provides an employment-based universal pension. Important changes to the Canada Pension Plan were recently announced by the federal government and seven provincial governments, in their role as joint stewards of the Plan. Changing demographics (low birth and death rates), lower productivity growth, enriched benefits and an increasing number of Canadians claiming disability benefits have increased the CPP's costs over the years. If federal and provincial governments had not acted promptly, premiums would have risen to 14.2% of contributory earnings in 2030. They were already set to slowly reach 10.1% in 2016. The chief actuary concluded that the fund would have been completely exhausted by 2015.


``Canadians should be encouraged to take increased responsibility for their economic security at retirement through individual and corporate retirement plans."

Ms. Gretchen Van Riesen (Past President, Association of Canadian Pension Management)


In order for the CPP to be sustainable and fairer to younger generations, governments agreed to speed up the gradual contribution rate increases. This results in higher near-term premiums but lower future premiums, a steady-state rate of 9.9% in 2003, instead of a steady-state rate of 14.2% in 2030.

To have further delayed the necessary changes to the CPP, as was done in the past, would have been totally unfair to our children and grandchildren. The intergenerational inequity of inaction would have been unforgiveable. Younger generations would have eventually faced an unbearable contribution rate to finance our retirement years. These proposed changes move the CPP from pay-as-you-go financing to fuller funding: the reserve fund will grow in value from about two years of benefits to about four to five years of benefits. This fund will be prudently invested in a diversified portfolio of securities at arm's length from governments, in order to earn higher returns.

The general consensus among witnesses was that the changes to the CPP were necessary and welcome.

Pillar 3 (RRSP, DPSP, RPP) provides tax-deferral incentives for employment-based pensions or individual retirement savings accounts. Important tax changes were enacted in 1990. Among other things, the modification resulted in a more equitable tax treatment for those who had employer-sponsored pension plans and those who did not. But, because of budgetary constraints, the government delayed the speed at which the contribution limit increased. Under the original proposal the limit was supposed to reach $15,500 by 1994.

The 1996 budget once again delayed increases in the RRSP and DPSP limits for a number of years. Under the original schedule, RPP and RRSP limits were supposed to reach $14,500 in 1997 and 1998 respectively. The budget froze the contribution limit at $13,500 until 2002 for RPPs and 2003 for RRSPs. Under the new schedule, the RRSP limit should increase to $14,500 in 2004 and $15,500 in 2005.

The Committee believes that the government should reconsider the contribution limits under the schedule announced in 1996.


    RECOMMENDATION


  • The Committee recommends that the schedule of contribution limits set out in the 1996 budget be revised so as to allow contributions to increase before 2002.

3.2 Enhancing Rates of Return: The 20% Foreign Property Rule


``... we continue to believe that the 20% foreign property rule should be eliminated to help Canadians create additional wealth and to obtain optimal diversification of their retirement assets."

Ms. Gretchen Van Riesen (Past President, Association of Canadian Pension Management)


Canada has, since 1994, had a 20% Foreign Property Rule limiting the amount of foreign investments that may be held in tax assisted pension and retirement savings plans. The limit was increased gradually from the 10% limit that applied before 1990. A number of witnesses argued that this restrictive 20% limit is detrimental because it limits the potential return that could be earned in a more diversified portfolio and increases the risk of the retirement portfolio.

Even though the Canadian equities market accounts for less than 2.5% of global stock market capitalization, 80% of Canadians' retirement savings must be invested here. This severely limits our ability to diversify globally and across economic sectors - it must be remembered that Canada's economy is still relatively resource-oriented. It is precisely because of the relatively small size of the Canadian capital market that an appropriate degree of diversification requires a relatively large foreign content. Sophisticated investors can use derivatives to effectively increase their share of exposure to foreign assets beyond 20%, without violating the income tax regulation. Some mutual funds are now also offering this ability.

The Committee believes that limiting diversification increases risk and can reduce the overall return. The Investment Funds Institute of Canada recently commissioned a study on the impact of the foreign property rule on investor returns. The study found that a 30% foreign content limit over the last 25 years would have allowed Canadian investors to earn up to 1.6% more per year on their retirement savings portfolios. The cumulative impact of this is enormous; for an average investor it means the loss of $32,000 in capital at retirement. Thus the existing rule merely makes some Canadian seniors poorer than they would otherwise be.


The Canadian Funds Institute of Canada has shown that an RRSP with 30% foreign content would be $32,000 larger at retirement for an average investor than it would be under current rules.

The 20% rule only affects savings in tax-assisted retirement vehicles such as RRSPs, RPPs, and the CPP investment fund. Thus it penalizes the returns of those whose savings are mainly in these instruments. Taxpayers who hold most of their savings outside of tax-assisted savings plans are less affected by the 20% rule. They can achieve maximum diversification to protect against risk and enhance their rates of return.


    RECOMMENDATION


  • The Committee recommends that the 20% Foreign Property Rule be increased in 2% increments to 30% over a five-year period. This diversification will allow Canadians to achieve higher returns on their retirement savings and reduce their exposure to risk, which will benefit all Canadians when they retire.

4. The Tax Treatment of Business

4.1 Variation in Effective Tax Rates

In the mid-1980s, the federal government broadened the corporate tax base while lowering the rates of tax applied to that base. Despite this policy, the average combined federal and provincial corporate tax rates is still 43% and Canada's corporate tax burden is heavier than that which applies in our most important trading partners.


The combined federal and provincial corporate tax rate has been reduced from 51.6% in 1987 to 44.6% in 1996, and from 24.9% to 21.1% for small businesses.

When compared to other industrialized nations, the corporate tax burden as a percentage of GDP is significant (see on page 56). The marginal effective tax rate on investment that a Canadian manufacturing company faces (25.5%) is high when compared to countries such as the United States (21.5%), the United Kingdom (20.2%) and Mexico (16.5%). It is low when compared to Germany (27.5%) and Japan (32%). Similar results prevail for the service industry, but the differential is generally larger (Canada 32.2%, United States 19.9%, United Kingdom 19%, Mexico 17.7%, Germany 33.1%, Japan 33.9%).

In addition to these discrepancies between countries, there is considerable inequality between the tax treatment of various sectors. For example, the effective corporate income tax rate for non-manufacturing businesses (communications, transportation, utilities, trades and construction) is high in comparison to those of the manufacturing sector, oil and gas sector and the mining industry. Generous write-offs for locating, acquiring and exploiting resource properties explain why the resource industry faces a much lower tax burden.

Testimony heard by the Committee confirms these observations. For example, the Canadian railways industry referred to the fiscal imbalance between Canada and the United States. They argue that Canada's major railways pay approximately 53% more in fuel, sales and property taxes than U.S railroads. More specifically, Canada's railways have to pay 4 cents a litre in excise fuel tax to the federal government while American railroads pay only 2.2 cents. In addition, railway tax depreciation rates in Canada are less favourable than in the U.S. The railway industry also argues that it faces a higher tax burden as a percentage of revenues when compared to other modes of transportation operating in Canada such as air or the motor carrier industry. The industry maintains that a proper fiscal environment would create more jobs and wealth in Canada.

Capital is highly mobile from industry to industry and from one nation to another. Large discrepancies between corporate tax rates, sectorally or internationally, will promote perverse capital flows and an inefficient allocation of capital between sectors.


    RECOMMENDATION


  • The Committee recommends that the government review the inter-sectoral variation in effective tax rates and remove any unwarranted variations. We believe, however, that any changes designed to equalize the tax burden should be revenue neutral or relieving.

4.2 Small Business Deduction

Corporations that are Canadian-controlled private corporations are eligible for a small business tax rate reduction. This preferential tax rate also known as the small business deduction (SBD), lowers the basic federal tax rate on the first $200,000 of active business income by 16 percentage points - from 28% to 12%. Hence the small business deduction cannot exceed $32,000.


``We think small business should be targeted for corporate tax relief. Increase the small business deduction threshold from $200,000 to $300,000. It needs to reflect the roughly 40% inflation since it was set in 1984."

Mr. Dean Wilson (President, Automotive Industries Association of Canada)


The SBD was put in place in 1984 to lower the federal corporate tax rate applying to Canadian small businesses. Since the inception of this tax measure, the ceiling has not been increased.

Many witnesses representing business organizations argued that it was now time to increase that threshold. It is true that the SBD has not kept pace with inflation or the growth in the size of small businesses. By increasing the SBD, small businesses could have access to a larger pool of low-cost capital, i.e. that generated by profits. However, increasing the threshold could have serious revenue implications for the government. Under the present $200,000 threshold, the lower tax rate for small businesses already costs the government $2.62 billion in 1997. It is estimated that these costs will likely increase to almost $2.78 billion by 1999. It is also estimated that increasing the threshold from $200,000 to $300,000, as recommended by some small business representatives, would cost the government almost $1 billion annually in additional lost revenues.


    RECOMMENDATION


  • The Committee recommends that the government carefully review the small-business deduction and the appropriateness of the $200,000 threshold level.

5. Supplementary Health and Dental Plans

One issue that has frequently arisen since the Finance Committee embarked on these pre-budget consultations four years ago is the tax treatment of supplementary health and dental plans. The possible taxation in the hands of employees of employer contributions to group health and dental plans was feared by many. The rationale for taxing these benefits would have been the inequity between those who had supplementary health and dental protection and those who did not and could not benefit from the favourable tax treatment.

Two years ago, it was estimated that 3.6 million Canadians were not covered by supplementary private or public health and dental plans: 2 million Canadians to whom employers could have offered coverage under group plans but did not, one million unincorporated self-employed entrepreneurs and their dependents whose health and dental coverage is not a deductible business expense, and 600,000 Canadians who are not employed, not eligible for special government plans and not covered as dependents under public or private plans. The 3.6 million figures is now lower because of the introduction of a universal drug insurance program in Quebec in 1997.

Instead of recommending the taxation of benefits, the Committee challenged the insurance industry in the past to find ways to increase the number of Canadians for whom supplementary health and dental plans are available. In response to this challenge the Canadian Life and Health Insurance Association and the Canadian Federation of Independent Business are now working together to assess the current degree of coverage, why coverage is less common among small business and what initiatives should be considered to increase coverage. The Committee is very thankful to the insurance industry for its efforts in this important area. They could affect not only the health of Canadians but also protect their economic well-being.

Making sure that all Canadians have access to supplementary health and dental plans is believed to be more important and fairer than taxing benefits. This is why the Committee is once again recommending the following important changes in regard to the tax treatment of supplementary health and dental plans.


    RECOMMENDATION


  • The Committee recommends that unincorporated businesses be allowed to deduct the cost of supplementary health and dental coverage from income, to put them on the same footing as the incorporated self-employed.

This measure should reduce substantially the number of unincorporated self-employed entrepreneurs who are not covered by supplementary insurance plans. A problem still exists for employees whose employers choose not to offer a plan. The Committee feels that these individuals and families should have the same options as the self-employed, and hence make the following recommendation.


    RECOMMENDATION


  • The Committee further recommends that employees whose employers do not provide a supplementary health and dental plan be able to deduct, from income, the costs of acquiring adequate private coverage.