*How we can beat the U.S.

Frontier Centre, Trade, Uncategorized, Worth A Look

Charlie Baillie says that if we put some passion behind it, Canada absolutely can challenge the U.S. elephant’s growth. Canada could overtake the U. S. economy in growth and, over the long term, even achieve average standards of living superior to U.S. standards of living. The issue is, how do we do it?

RICHARD HARRIS A bunch of policies and framework are already in place that are likely to keep Canadian growth rates high for some time. So that’s a start. The question is, what policy environments would accelerate these trends and possibly lead us to higher income levels? The tax environment is critical, and we’re moving in the right direction.

Secondly, the provinces and the federal government have to continue to both preach and practise prudence. British Columbia has yet to get in line here, and that’s likely going to happen soon. We need a lot of investment in education — I think the returns to higher education in Canada are extremely good and will continue.

And lastly, there’s the issue of the monetary regime. I do think that we have to move towards closer co-ordination on U.S.-Canada monetary policy, and, more explicitly, some kind of fixed-exchange-rate monetary regime.

ROGER MARTIN And we need a business sector that recognizes that it’s got to be innovative and it’s got to be striving to be globally competitive, not just competitive in the Canadian context. If we did all those things, we could grow faster than the United States in the 21st century.

HOW FAR AWAY ARE WE ON THE TAX GAP BETWEEN US AND THEM?

JACK MINTZ Right now, Canada’s taxes as a percentage of gross domestic product are in the order of 10 points more than the United States. One would not be concerned about that if governments were spending the money wisely. And it’s not just the total burden of tax that matters, but also the structure of taxation. I think there’s a very strong need to shift from taxes on earnings of individuals to taxes on consumption.

IF YOU HAD TO PICK A NUMBER AS TO HOW BIG YOU THINK GOVERNMENT SHOULD BE IN CANADA RELATIVE TO WHAT IT IS NOW, WHAT WOULD YOU PICK, JACK?

MINTZ Canada and the United States had very similar-sized public sectors back in the 1960s, about 30% of GDP. Canada is now over 40% and the United States is just a little bit more than where they used to be. Some growth-maximizing studies suggest 25% to 30% of GDP would be optimum. I would think that one really doesn’t need government more than a third of GDP, which means that Canadian governments are probably nine points above where they really should be.

DAVID, FROM YOUR PERSPECTIVE DOWN IN CALIFORNIA, 30% OF GDP — IS THAT A GOOD NUMBER?

DAVE HENDERSON Well, 30% is a good figure to aim for. I think actually you can go a lot below that, especially if you’re talking about probably a 30-year transition. I basically don’t think government does anything very well. It can spend money quickly and it can spend a lot of it, but when government is spending money, it’s spending money on things it wants, and what various special interests want. But when we spend our own money, we’re spending it on what we want, and we do a much better job of spending our own money by our values than government does spending it by their values. ??? over the long run, in both Canada and the United States, a government sector be well under 10% of GDP. Now, that would be a 40- or 50-year transition, because of things like the Canada Pension Plan, or Social Security in the United States, which would have to be a slow transition.

MARTIN There’s an analogy here to the corporate world. It’s not so much the percentage of money spent as the way the money is spent. To what extent do those expenditures create revenue? Whatever is being spent, and this is Jack’s point, is not producing enough growth, and so the percentage drifts up over time, because we’re spending way too much on consuming current prosperity as opposed to spending to build future prosperity. That’s what we’ve got to change.

PICK TWO THINGS THAT THE GOVERNMENT SHOULD BE DOING NOW THAT WOULD BUILD FUTURE PROSPERITY.

HARRIS Education.

MINTZ It’s not just a matter of spending. Government spending money on education is just an input. What we really want to know is, what do we accomplish with the money that’s being spent? There is a role for governments in education, but I think it’s very important that we have a competitive education system, at least in terms of competitive suppliers, and that decisions are accountable. We need some way of measuring how well we are using the money. Canada actually has one of the highest high school dropout rates amongst OECD countries. That doesn’t say much for an education system.

HARRIS You know, Canadian preferences for delivery of particular goods through the public versus private sector is probably not going to change dramatically. What we need to do is convince Canadians that they need to invest more. I think we can reduce the size of government by, say, 10 points. What we really need to do is shift the focus from this public versus private debate toward the issue of investment. That will have more leverage in terms of influencing policy outcomes than an extensive ideological debate about whether something should be done in the public or private sector.

MARTIN You’re talking about making the transition from a 40 world to a 30 world, and I think one natural piece of it is going to have to come from eating it up with economic growth. That means having greater incentives to work, save and invest. And that means having fewer incentives to not work the incremental hour, not save the incremental dollar.

MINTZ A major reduction in debt, down to, let’s say, about 25% of GDP over the next 20 years, would result in very substantial interest savings. Likely, we could accomplish half of that 10% objective just by cutting debt and translating those interest savings into major tax cuts.

For the other half, you have to basically constrain programming. The growth of government in Canada relative to the United States hasn’t been in health; it hasn’t been in education; and it hasn’t been in infrastructure. It’s been in regional development programs, which I think are totally ineffective. We designed a very bad unemployment insurance system. We reformed it in 1994, but now we’re backtracking on those reforms. There’s a whole bunch of areas where you can see that programs are not working very well.

Even in the case of infrastructure. I don’t think government should subsidize infrastructure heavily. Some countries have done a very good job providing infrastructure without huge investments by governments alone. Governments help harness resources, but a lot of it can be done through the private sector.

My feeling is that you can get another five percentage points quickly off the size of government over the next 10 or 15 years if you take a hatchet to things that really don’t work well, and use more innovative ideas.

HENDERSON A way for Canadians to think about Canada is to have Canada become kind of the Hong Kong of North America — just slash tax rates; slash tariffs even further, although they’re pretty low, but slash them down to zero; slash regulations — and you can be a haven for all that capital that wants to get out of higher taxed areas, including United States.

MINTZ What’s quite important is that in Hong Kong there’s a lot of capital that is exempt from taxation, such as interest on bank accounts and bond interest, etc. As a result, the tax system is much less discouraging towards savings.

On top of that, Hong Kong’s whole public sector is organized outside the sector. In other words, infrastructure is provided by the private sector, such as the subway system. It’s completely privately run. As a result, they’ve been able to keep their expenditures at a level so that their taxes are relatively low.

CANADIANS DO NOT LIKE TO HEAR THE WORDS “SLASH” AND “GOVERNMENT” IN THE SAME SENTENCE. HOW DO YOU SELL THIS TO THE AVERAGE CANADIAN? HOW DO YOU TELL PEOPLE THAT THEY’RE GOING TO GIVE UP SOMETHING IN RETURN FOR BETTER GROWTH TEN YEARS DOWN THE ROAD?

HARRIS Political leadership is critical. Occasionally, in our past, we’ve had prime ministers who have articulated more growth-oriented visions than the current political leadership. If enough people have these kinds of conversations, you will get a bottom-up demand largely motivated by concern about where our kids are going to be in 20 years. The brain drain has really struck a chord. The tone of the discussion is somewhat more urgent than it was a decade ago.

HENDERSON I agree with the bottom-up thing. I was in Washington for a few years in the Reagan administration, and, except for rare moments, the federal government followed rather than led on the idea front. I would never try to sell this idea by talking about growth rates being 1.6 percentage points higher. Their eyes will glaze over. I would do it in terms of what they get to have fairly soon. If you cut marginal tax rates and you cut government spending, they’re going to have more. They’re going to have, maybe, less of this government program and less of that government program, but they’re going to have more of their own money to spend on what they want. That’s how tax-rate cuts were most successfully pitched in the United States.

MINTZ People are becoming more and more willing, especially among the younger ages, to really look to see what they can provide for themselves. As a result, I think politics in Canada has shifted quite significantly over the past ten years. Government policies are not what Canadians are going to be looking for. They’re going to be looking for a stripped-down government that does the things that it should do, and much lower taxes, including marginal tax rates, so that they can compete better in the world.

I’D LIKE TO GO BACK TO A POINT JACK RAISED EARLIER, ABOUT TAXING CONSUMPTION RATHER THAN INCOME.

MARTIN That is definitely one of the ways we could give a positive jolt to the economy, if we simply switched from taxes on income to taxes on consumption. Keep the progressivity, if that’s what Canadians want. It’s income, less savings. I think it would provide a real jolt to the economy if we dulled the relationship between working an extra hour and paying extra taxes. That’s the kind of thing we’ve got to do. We could give people lifetime tax breaks. Rather than saying the first $7,000 you make every year of your life is tax free, I’d make the first $250,000 you make in your life tax free. That would be an incentive for young people to stay, establish themselves in this country, and it would give them tax breaks when they need the money most, when they’re forming a family, buying their first house.

HENDERSON We had a version of lifetime averaging up until 1986 in the United States. Until the Tax Reform Act, we had a little form you’d fill out called Schedule G, and it would allow you to average the last five years of your income. It’s not close to what Roger talked about, but it’s in that direction.

MINTZ You could do that under an expenditure tax. You could get the averaging on a lifetime basis. In fact, people have talked about expenditure taxation as equivalent to a tax on lifetime earnings.

Let me just add that no country has adopted a full-blown expenditure or consumption tax. But there’s been a lot of work done by tax policy analysts over the years that’s shown that this system is not only simpler and easier to administer, it can lead to a huge increase in income per capita and growth in the country. I think that when you talk about innovative ideas and things that can be put into place, this one is getting easier — a slam dunk — for our country.

HARRIS You really can’t talk about narrowing income gap without addressing this issue of Canada in the North American context. We’ve got our exports now to 46% of GDP. Most of those exports are going to go to the United States. It’s very difficult to imagine how Canada can reach higher income levels similar to the United States without expanding our U.S. exports. It’s difficult to imagine that a Canada that continues to trade at its current levels is going to reach this target. It’s going to require some very high value-added exports in a larger number of areas. The chances of that going to Europe or Asia, it seems to me, are relatively slim. So, our big market is the North American market, and we have to concentrate on that.

HENDERSON I think we are moving in the direction of a common market, with NAFTA, for example, and the free trade agreement before it. I don’t think Rick was implying this, but a bad idea would be to target 80% or 90% exports to the United States, because then you get all the silly government kinds of programs that Roger talked about.

HARRIS I agree that, in principle, we ought to just let markets dictate where our exports will go, but the fact of the matter is that the World Trade Organization is in some difficulty. We’re talking about a medium-term policy. The question is whether we do something about [expanding] NAFTA as opposed to putting our eggs into other baskets. Ontario has had the highest growth rate because its U.S. exports-to-GDP ratio is approaching one. The fact of the matter is, the U.S. boom has been a tremendous asset to the Ontario economy.

The other agenda is the border. The whole rules-of-origin system is completely antiquated, and is essentially a burden and creating tremendous transaction costs at the border. All our shippers and our manufacturers want to get rid of this system. There are a number of positive things that we can do in the NAFTA context that would promote economic growth in Canada and hopefully in the United States as well. On the multilateral front, that’s simply not the case.

MINTZ I agree with David on this. Simply concentrating on the U.S. market would be a mistake. A lot of Canadians are investing in many other parts of the world besides the United States. In fact, only two-thirds of our foreign direct investment goes down to the United States, unlike our trade, which is over 80% with the United States. I think we should have an open mind and not try to focus too much on one country alone. Now, with respect to having a common currency with the United States, I think that will become a valuable idea, particularly if we feel, at some point down the road, that there are significant advantages in reducing the cost of transactions for Canadians dealing with the U.S. market, so we can quit worrying about exchanging currency. But I’m just not sure at this point whether we’re quite ready yet to move to a common currency relationship with the United States.

HARRIS I don’t know of a single small country that has been successful with a flexible exchange rate regime or where it didn’t lead to substantial depreciation. Virtually all the successful high-income small countries — Finland, Netherlands, Hong Kong — virtually all went to fixed currency regimes. I think the depreciation of the Canadian dollar has essentially passively given Canadians a very large income wage cut without calling it that.

MINTZ But if you look at some countries that have had either currency boards or fixed exchange rates, their stories are actually not very positive, Rick. In fact, it’s gone the other way. They’ve actually had tremendous difficulty recently or have had difficulty in managing their fixed exchange rate

HENDERSON I must say I’m pleased with the degree of consensus we reached on a lot of these things. I mean, everyone agrees that we ought to drop marginal tax rates. Everyone agrees that we ought to cut government spending as a percentage of GDP by at least ten percentage points. I think that’s a dramatic contradiction of the usual joke people make about economists never agreeing about anything