Thank you, Mr. Chairman and members of the committee.
Good afternoon. It's great to be back with this committee. It's a very, very friendly place to be—sometimes, anyway.
I'd like everyone to recall, as always, that while I am vice-president for research at the C.D. Howe Institute, I'm speaking on my on behalf and not that of my members and board of directors, who may not agree very much with the things I say.
To move on, I'd like to emphasize a few of the points raised by Mr. Page, including some points of agreement and some points of emphasis, and then to extend them a little bit in a policy direction.
First, you will have heard from economists for a very long time, and will continue to hear, a story about uncertainty. Economic output forecasts are always uncertain. They're especially uncertain in current times. This is an issue for budget-makers right now, because despite that degree of uncertainty, the fiscal prudence contained in the budget and the economic outlook averages only about $1 billion annually over the six-year horizon. That's about half a percentage point of revenue, or not very much. It's lower than the historical contingency reserve and lower than the economic prudence amounts of about $4 billion annually. That was about 2% of budget revenues looking back to previous years.
The point about this is that arguably it's not enough in a volatile economic environment, where fiscal projections are going to be prone to errors—and potentially big errors. That's one of the reasons it's plausible, as Mr. Page said, to look to the out-years of the planning horizon and to suspect that positive or balanced budgets may not be the most likely outcome.
So there are reasons to have some doubt, just based on volatility, about the economic forecast and the uncertainty about the forecast.
There are a few risks, some of which Mr. Page pointed out, but I'll add some others. One is that the outlook assumes a pretty low long-term financing rate for the federal government. The $2 billion to $3 billion in savings in annual debt services owing to low interest rates could come true. No one is expecting interest rates to go up very quickly right now—absolutely not—but there certainly is a risk. In bond markets, we'll be looking at higher interest rates down the road, and potentially not very far down the road.
What else are we assuming collectively among the private forecasters or from a federal perspective? We're assuming that unemployment comes down fairly quickly and that the labour market performs strongly. Again, that may well happen, but it's hardly baked in.
The other assumption in the outlook that takes us to roughly zero balance by 2014-2016 is that there will be no major new spending initiatives over the next five budgets. Again, that could be true, but it's a bit of a crash diet. It's going to take a lot of discipline to stay on it. It's great if the federal government is able to do so from a planning perspective and a fiscal perspective, but it will take a lot of willpower. That's what budget-making does, just like any diet does. So that's important, too.
Another observation is that notwithstanding these risks, the outlook for the federal government is relatively strong or positive compared with the provincial governments, where we have some major cost drivers. Mr. Page referred to the demographic pressures on health expenditures, in particular from an aging society—a story that we're very familiar with. Most of these costs are going to be centred on the provinces, where a lot of the socially driven or demographically driven spending occurs.
So those are some significant risks in the overall government budget-making process, which are going to put pressure on the federal government, obviously, particularly because of health care and looking to 2014 and beyond for it, when the current agreement for health transfers needs to be renewed. We have a more or less steady as you go, fairly quick growth rate built into health spending in the outlook right now. That's going to be an issue that will have to be dealt with by 2014. It's going to mean that the questions about fiscal imbalance will be back on the table not very long from now. Those are some familiar issues.
In particular, from a tax-raising or revenue-raising point of view, there's a question about who's going to raise the revenue to finance these growing expenditures on health. Will it be the federal government or will it be the provincial governments? For the most part, the federal government and the provincial governments occupy the same tax basis. That means that when you're talking about corporation income taxes, personal income taxes, sales or consumption taxes, the federal and provincial governments share all of those things.
So there will have to be, or perhaps there ought to be, some trade-offs as far as tax room goes in the next few years, in order that the revenue-raising ability will reside or be held by the level of government that has to conduct the spending that's funded by those taxes.
After alerting or pointing out to this committee some of these risks and emerging issues, I did want to make a few closing recommendations.
One, notwithstanding some of the spending risks, we, or I, don't see that much of a risk on the revenue side necessarily for the federal government. We don't see a reason to shy away from the government's planned path on corporation income tax relief. If you think about economic growth in the long run and the way corporation income taxes work, in the long run, tax relief from where we are, at 18% federally, is likely to have a positive net impact on government balances. In other words, a one percentage point drop in the current 18% federal corporation income tax rate in 2010, in the long run, is going to have a positive impact on federal revenues—not in the short term necessarily, but certainly in the long run. That's just the way corporate taxes work, because of the incentives for investment and growth and the way that corporations tend to respond to investment incentives.
The same corporation income tax reduction is potentially good for the provinces because of the growth in the tax base. Economic growth also drives provincial income growth. So there are positive externalities there as well; the provinces do well when the federal government drops its corporation income tax rate. But this is part of a plan that's essentially baked into the outlook right now, and I think it would make sense to stick with that plan.
I'd like to look back to the balance between the federal government and the provinces and to what some of us were saying a years ago about the balance between the taxing authority, corporation income tax room for the federal government, and also personal income tax room and sales tax room.
If you look back to 2005, I co-wrote, with Mr. Stephen Tapp, a paper that recommended that the federal government drop its personal income tax rate, drop the GST rate by two percentage points, and leave room for the provincial governments to raise their consumption taxes in order to fund the health spending that was necessarily part of their programs. We're part of the way there. We have seen the federal government drop 2% off its GST rate. It's important, though, that any tax room the provinces take up be smart tax room—in other words, not economically damaging tax room.That's why the conversion in Ontario and B.C., as well as Quebec and three of the eastern provinces, going back to 1997, to a harmonized sales tax system is good. There you have a smart tax system on which the provinces can put more weight. So we've created room for the provinces to do more of their funding through the HST and to fund more of their own health expenditures, and there is less pressure on the federal government to finance provincial spending through federal taxation.
So we need to start talking more about the balance between taxation and transfers from the federal government to the provinces and how the provinces set their own tax rates and finance their own spending needs.
With that, Mr. Chairman and committee, thank you.
I cede the floor.