Analysis

Surging U.S. deficit a warning for Canadians wanting tax cuts: Don Pittis

A call from a Canadian Senate committee to follow the U.S. lead in cutting corporate taxes comes just as the hazards of that policy loom larger south of the border.

U.S. Senate leader wants cuts in social programs to pay for benefits that go to the rich

Finance Minister Bill Morneau says he is working on a plan to help Canadian businesses compete in the face of the corporate tax cuts in the U.S. (Christopher Katsarov/Canadian Press)

According to a new Senate report, what Canada needs is for its rich people to get richer.

Of course that's not what it says in so many words, but in calling on the Canadian government to follow the U.S. in cutting corporate taxes, that is effectively what it is asking for.

Perhaps it's simply a matter of bad timing, but the Senate banking committee report titled Canada: Still Open for Business?, obviously in the works for a while, has hit the media just as two serious flaws in the U.S. tax-cutting strategy made headlines in the U.S.

Of the six recommendations listed in the report, five are hard to argue with in principle.

Act immediately

Whether a three-year-long royal commission is the way to go about it, a study of Canada's taxation system, looking for efficiencies and examining its competitiveness, is a reasonable part of government housekeeping to keep the country's revenue policy current.

Cutting red tape, helping companies develop and preserve their intellectual property, encouraging trade efficiency and expanding exports to the world's fast-growing economies, including China and India, seem like ideas worthy of cross-party support.

But recommendation No. 2, the one that has attracted the headlines, could turn out to be more controversial.

It suggests "the federal government act immediately to implement measures that would encourage companies to continue to invest in Canada, such as reducing the corporate income tax rate and temporarily allowing the full and immediate deduction of capital expenditures."

At a question-and-answer session in Toronto yesterday, Finance Minister Bill Morneau said the government is already examining ways of using tax reform to encourage Canadian businesses to invest in Canada rather than chasing lower taxes south of the border.

"What we're trying to achieve is to make sure that Canadian businesses have the opportunity to invest in a way that is competitive with their potential investments in the United States," Morneau said.

"We have to think about how we get there."

The U.S. tax-cut advantage

As he considers his options, Morneau will have to consider two recent developments that may colour the advantages or disadvantages of following the tax-cutting strategies of U.S. President Donald Trump.

Last week, George Athanassakos, a professor at Western University's Ivey Business School, wrote a column that blamed high taxes, regulations and red tape — what he called the "Trudeau Effect" — for Canada's lagging stock prices.

His timing was inopportune. The same day his column came out, the Dow Jones Industrial Average plunged 830 points, a decline of more than three per cent, and New York's Nasdaq index was off four per cent.
A screen above the floor of the New York Stock Exchange shows the closing number of the Dow Jones industrial Average last Wednesday. The Dow plunged more than 800 points, its worst drop in eight months, led by sharp declines in technology stocks. (Richard Drew/Associated Press)

Clearly, the "Trudeau Effect" was heading south.

Lo and behold, Toronto's stock market index was down as well, but by a lot less. Widespread analysis from the U.S. blamed the Dow and Nasdaq's precipitous decline on their precipitous rise following the U.S. tax cuts. Companies had been taking their tax gains and buying back their own stock, creating what may have been excessive exuberance and a temporary spike in prices.

In what some described as a sugar high, the U.S. economy and stocks were surging for the wrong reasons. Fear of a trade war with China meant buyers were stocking up on imports before losing access. Meanwhile the tax cuts, which profited stocks and their shareholders when they were introduced, had done much less to stimulate productive investment and the more lasting benefits that come with it.

Hot, but maybe too hot

And there were other consequences of using stimulus to push an already strong economy into overdrive.

Lower taxes, when unemployment was already low and just as the economy was being juiced by low interest rates and  government spending, meant Federal Reserve chair Jerome Powell had little choice but to begin a series of interest rate increases to prevent inflation from getting out of hand. That, in turn, destabilized the bond market.

Critics argued the tax cuts were little more than a way of transferring money from government coffers to wealthy, stock-owning Americans. 

Au contraire, said supporters, cutting taxes for the rich would end up generating more revenue in the long run. 

But a second story this week shot holes in that argument. The U.S. deficit has soared under Trump, up 17 per cent to the highest level since 2012, when the U.S. was still suffering the effects of the Great Recession.
Senate majority leader Mitch McConnell says a 17 per cent increase in the deficit under the Trump administration was not due to tax cuts, but because social services cost too much. (Joshua Roberts/Reuters)

The way out of that problem? According to U.S. Senate majority leader Mitch McConnell, it's to chop spending on social programs that disproportionately benefit the poor such as Medicare, Medicaid and Social Security.

Many critics, including our own foreign affairs minister, Chrystia Freeland, have warned that world governments are being taken over by the rich and powerful. And there is plenty of evidence that making the rich richer and the poor poorer is not in the long-term benefit of Canadians or Canadian business.

Successful businesses need customers who are rich enough to buy their products. Successful businesses need a highly educated, healthy population, where everyone feels like a valued member of society, capable of participating in and helping to create the next stage of a dynamic economy.

While Morneau thinks about how to keep Canadian business investment at home, he will no doubt be considering whether the U.S. game plan is ultimately the best one. He may decide that a more moderate strategy, one that doesn't make the rich richer and the poor poorer, will ultimately be better for Canadian business in the long term.

Follow Don on Twitter @don_pittis

About the Author

Don Pittis

Business columnist

Don Pittis was a forest firefighter, and a ranger in Canada's High Arctic islands. After moving into journalism, he was principal business reporter for Radio Television Hong Kong before the handover to China. He has produced and reported for the CBC in Saskatchewan and Toronto and the BBC in London. He is currently senior producer at CBC's business unit.