Finance Committee on April 24th, 2007

[The Chair, Conservative, Brian Pallister]

The orders of the day, pursuant to Standing Order 81(4), are the main estimates for 2007-2008: votes 1, 5, and L10 under Finance, part III, report on plans and priorities, referred to the committee on Tuesday, February 27, 2007.

Welcome to our witnesses. This morning we have officials from the Department of Finance. I understand there is a brief opening presentation.

Mr. Carney, please proceed.

[Mark Carney, Senior Associate Deputy Minister, Department of Finance]

Thank you, Chair.

Good morning, members.

Good morning, Mr. Chairman.

My name is Mark Carney, and I am Senior Associate Deputy Minister at the Department of Finance. Departmental representatives are with me today and will help me answer your questions.

We believe the committee has met with other members of the Finance portfolio on separate occasions: the Canadian International Trade Tribunal, the Financial Transactions and Reports Analysis Centre of Canada, the Office of the Superintendent of Financial Institutions and the Office of the Auditor General.

So the discussion today focuses on the Main Estimates of the Department of Finance. As you probably know, the department is responsible, in particular, for preparing the federal budget, developing tax and rate-setting laws and policies, managing federal loans in the financial markets, administering the main funding transfers to the provinces and territories, developing regulatory policy for the Canadian financial sector and representing Canada to international financial fora and institutions.

The estimates that have been tabled in the House identify total budgetary requirements for the Department of Finance of $75.8 billion. It is important to note that $75.5 billion, or over 99% of this amount, relates to statutory votes for items that have already been approved by Parliament through enabling legislation. These include items such as the payment of public debt charges, Canada health and social transfers, and equalization payments. These statutory votes are displayed in the estimates document for information purposes and will not be included in the appropriations bill.

Within the statutory votes there is a net increase of $2.4 billion over the last year, with the major contributing factors being a $2 billion increase in transfer payments to provinces and territories and a $302 million increase in public debt costs.

The non-statutory votes of the Department of Finance show a decrease over the last year. This consists of a $183 million reduction in grants and contributions related to payments made by Canada under multilateral debt relief initiatives, as well as a decrease of $3.8 million in the operating vote primarily related to sunsetted funding for the department.

We will be pleased to address any questions the committee may have.

Thank you.

[The Chair, Conservative, Brian Pallister]

Thank you very much, sir.

We're going to start with Mr. McCallum.

[John McCallum, Liberal, Markham—Unionville, ON]

Thank you, Mr. Chair.

It's a pleasure to have the opportunity to ask a few questions of Mr. Carney, a man I've known in a previous life. I have great respect for his professionalism, intelligence, and integrity, if not his ability to predict the timing of the shift-over of prime ministers in the U.K. The two of us have a bet on that subject.

I'd like to ask about interest deductibility. I must say I'm a little puzzled, because here is an item presented in the budget as if it will cost $40 million a year. Now we have the Chamber of Commerce saying it will be $1 billion to $2 billion a year, and people in the private sector I've spoken to have a similar view. So how can this item, which is turning out to be a huge tax measure, be introduced into the budget with an estimated revenue impact a tiny fraction of what experts now tell us it will be?

[Mark Carney]

Thank you for the kind words at the start, and also thank you for the question. I'm feeling a bit shaky, and I take the advisement of the committee that this is a non-monetary bet on the timing of that change. That's much appreciated, because I think I might lose on my timing on that.

On the cost of the interest deductibility measure, it's important to note that the proposal in the budget has a transition mechanism, depending on the type of debt. What shows up in the budget framework--which is a two-year budget framework, as I believe the member knows--is new debt for foreign affiliates, so it only addresses new debt. With the arm's-length and non-arm's-length existing debt, the measure takes effect beyond the budget framework, and that explains the level of the estimate.

[John McCallum, Liberal, Markham—Unionville, ON]

I don't think the experts claim, even in the time horizon of the budget, that $40 million is a gross underestimate of that, because some of the transitioning will have taken effect.

With respect to my second question, it's clear that in a perfect world, if Canada was the whole world, this might be a good policy; farm subsidies might be a bad policy. But we are a smallish open economy. If Europe and the U.S. have big farm subsidies, we have little choice if we want farmers to exist.

Similarly, with interest deductibility, when most European countries, the United States, and Japan all allow interest deductibility or its equivalent, and we don't, then our companies are operating in global markets with one arm tied behind their backs. I've seen a mathematical calculation that if you're financing an acquisition of 50% debt and 50% equity, interest deductibility alone will mean that these foreign companies can pay 37% more for a foreign acquisition than a Canadian company.

It's a huge measure, which will seriously weaken our companies. In summarizing the impact, KPMG said it would lead to, and I quote, “more foreign takeovers of Canadian companies, stifled Canadian investment in global markets, an exodus of head offices and a weaker Canadian economy overall”.

So my question is, why would the finance department have such a huge hit on our relatively small number of global players? I acknowledge that there are some problems with interest deductibility, such as thin capitalization rules, but instead of dropping a bomb on the whole business, why did you not selectively go after those particular problems that I acknowledge to be problems?

[Mark Carney]

Thank you.

I believe the question relates to the competitiveness of Canadian corporations internationally. I'll make one observation that I'm sure we'll have a chance to discuss in detail later in the session. There is a broad competitiveness strategy of this government that is outlined in Advantage Canada, which was tabled with the fall update and began to be implemented in the course of this budget. I won't belabour the specific aspects of that, but I trust we will address some of them later on.

From a tax competitiveness perspective, the government firmly believes in tax competitiveness. It has made substantial strides in enhancing the competitiveness of the Canadian tax system.

Regarding another reference to Advantage Canada, the objective of the Canadian government is to achieve the lowest rate of tax on new business investment in the G-7. When the government came to office, Canada was sixth in the G-7, i.e., the second-highest marginal effective tax rate on new investment. As a result of measures put forth in budget 2006 and proposed in budget 2007, Canada will move to third in the G-7. The intention of the government is to continue to advance that progress. So the totality of the tax system is important.

It is also important, when looking at other jurisdictions, to look at the totality of their tax system. Whereas some jurisdictions will allow this deductibility, in a normal case they will tax the repatriation of foreign income into their jurisdiction, or they will provide other limitations on the absolute amount of interest that can be deducted in funding foreign affiliates. So we would look both to the taxation of foreign income that continues to be exempt in Canada, which is a major competitive advantage for Canadian multinationals, as well as measures that include restrictions on the amount of dividends that can be repatriated, etc., in places such as France and Germany.

It is a broad subject. There are a number of issues. The government is committed to competitiveness in the context of tax fairness.

[John McCallum, Liberal, Markham—Unionville, ON]

I think truth in advertising requires one to change the name from “Advantage Canada” to “Disadvantage Canada”. The annual survey of CEOs gave the government a failing grade on business taxation in general.

I've spoken to many experts on this interest deductibility issue. They are very clear that not every European country, but most, and certainly the United States and Japan, afford this privilege to their companies. We are the boy scouts of the world. Perhaps on the grounds that in some pure sense it's better tax policy, we are crippling our own companies in competition with those players.

[The Chair, Conservative, Brian Pallister]

Merci, monsieur.

[John McCallum, Liberal, Markham—Unionville, ON]

So I've run out of time.

[The Chair, Conservative, Brian Pallister]

Correct.

Monsieur Crête.

[Paul Crête, Bloc, Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC]

Thank you, Mr. Chairman.

In the Main Estimates 2007-2008, under the heading “Federal-Provincial Relations and Social Policy,” we note a significant cut to allocated funding, a reduction of 26.7%.

Does that mean that, for the Department of Finance, the entire question of the fiscal imbalance is no longer being addressed in anticipation of a future year?

[Mark Carney]

Thank you for the question. I'll introduce the answer and then turn to my colleagues to supplement it.

An important element of that decrease is that there was money allocated, as I believe you're aware, for the expert panel on equalization. That money is running off. It was a $10 million budget amount spread over two years. As it runs off, it brings down the amount allocated to that branch--whose important work continues, absolutely. Then there's an additional impact, because we allocate overhead costs based on budgets. That also reduces the amount.

I don't know if you need a further supplement, but that's the thrust of the change.

[Paul Crête, Bloc, Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC]

Do you intend to study the possibility of resolving the fiscal imbalance issue for good by focusing, for example, on tax transfers, the transfer of GST points? Does this budget cut simply mean that you have no intention of continuing to address these questions?

[Mark Carney]

The measures outlined in budget 2007 restore fiscal balance in Canada. The efficiency, effectiveness, fairness of federal-provincial programs--transfer programs and shared programs--will always be a subject of work at the department, and will continue to be an important subject of work going forward.

[Paul Crête, Bloc, Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC]

I'll continue on in another line of thinking. You've had to look at the impact of a 1% GST cut. In your report, you state the following:

[...] reducing the GST by an additional percentage point starting no later than 1 January 2011 [...]

I'd like to know a little more about the criteria you use to evaluate the impact of this measure on productivity.

I'll submit an assumption to scenario: a 1% GST cut makes it possible to buy lower-cost products, but it is possible to buy products manufactured outside Canada, in China or other emerging countries. However, one could apply a strategy whereby the manufacturing sector has better coverage, as you started to do in the context of this budget.

Are you going to study this kind of question by evaluating the impact of the change to the GST?

[Mark Carney]

There is an important question embedded in your comments, and that's the impact of retail sales tax; I'll go to the impact on manufacturers particularly. In several of our larger provinces, there continues to be a retail sales tax, which punishes manufacturers because there's not the value-added component.

We demonstrate in the budget a desire--the minister has made this point repeatedly--to encourage tax harmonization in Canada so that those provinces, for example Ontario, would move toward a value-added tax, a PST like Quebec's. This would make a significant impact on the competitiveness of Canadian business. To be specific, I spoke earlier about our rate of tax on new business investment going to third. If Ontario and B.C. moved to a VAT, we would have the lowest METR in the G-7 by some considerable margin.

The other point, if I may, is that one of the first things the government said upon arriving was that Canadians pay too much tax. Part of the impact of lowering the GST is clearly just to reduce the tax burden on all Canadians.

[Paul Crête, Bloc, Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC]

To clarify my question, I'd like to know the measures you are going to evaluate in order to determine what contribution would be likely to increase competitiveness. I know that people are still paying too much tax, but it is possible that a 1% cut will result in increased consumption.

Are you going to examine the question whether that would have the effect of exporting jobs, in that the 1% cut would make it possible to buy more products manufactured in China, India or other countries of the world? The tax cut would then have the final result of reducing the positive impact on Canada's economic activity.

Are you going to evaluate this kind of question?

[Mark Carney]

Both countries pay GST. Consequently, the system is neutral whether the product is manufactured in China or in Canada.

I can turn the floor over to Director General Brian Ernewein so that he can give you more details.

[Paul Crête, Bloc, Montmagny—L'Islet—Kamouraska—Rivière-du-Loup, QC]

The question isn't whether both countries pay the tax, but rather to take into account the fact that a 1% tax cut will result in increased consumption. It remains to be determined whether it's consumption of products from outside the country that will increase or that of products manufactured in Quebec or Canada. You also have to evaluate that effect. I want to know whether you intend to do it.

[Brian Ernewein, General Director, Tax Legislation Division, Tax Policy Branch, Department of Finance]

I apologize for answering a question with a question, but it seems to me, following Mr. Carney's remarks, that as far as a sales tax or consumption tax in Canada is concerned, we have neutrality in the system today. Whether a good is produced in Canada or produced in China, when it is purchased in the retail sector by a Canadian consumer, it will be subject to the same level of tax. My suggestion, perhaps, is for us to consider whether underlying that we have the right level of taxation on the production of profits.

[The Chair, Conservative, Brian Pallister]

We'll continue with Mr. Dykstra.

[Rick Dykstra, Conservative, St. Catharines, ON]

Thank you, Chair.

A couple of things that strike out in terms of looking at the overall estimates concern the increase from 2006-2007 to 2007-2008. I wonder if you could comment on how you arrived at the figures. I see the Department of Finance's main estimates increased by $2.2 billion, or 2.9%, compared to the 2006-2007 main estimates.

Could you just comment overall on how we've arrived at those figures? Sorry if I've....

[Mark Carney]

No, no. It's on topic.

The first element is.... I'm sorry, I apologize for using your time to find the right tab.

[Rick Dykstra, Conservative, St. Catharines, ON]

The chair is generally lenient on these issues.