TD: Canada's economic "cruising speed" to slow post-recession

TD Economics released a report Thursday which tackles an issue that's been broached by the Office of the Parliamentary Budget Office and some other private sector forecasters: What will the 'new normal' be for Canada's economy once it and the world emerges from the recession?
This is not an exercise in econometric navel-gazing. It is a crucial question for politicians as they develop public and fiscal policy measures now that will have significant effects on Canada's ability to look after its unemployed, its seniors, and the quality of life of all its citizens in the years to come.
Unfortunately, though there is a growing body of work from the PBO and private sector forecasters on this subject, the federal Department of Finance has been frustratingly silent at best on this issue and horribly wrong at worst. Parliament's Budget Officer Kevin Page, in his assessments of the budgetary 'new normal' has complained that finance officials have not provided him with some of the key data models the government is using when it develops forecasts about our econonomy and the federal budget.
How does the econometric rubber meet the road? Simple: Prime Minister Stephen Harper has said repeatedly that, though we will post the biggest deficit in Canada's history this year, we will, by and large, naturally “grow out” of deficit as our economy improves. Tax revenue — mostly related to corporate profits – will grow while recession-related expenditures such as higher unemployment insurance costs will decrease. Sure, there may have to be some modest spending controls – not spending reductions, mind you, just a slowing of the growth of government spending — but no one need think that the federal government a few years from now will have to make drastic cuts or – gasp – raise taxes.
But the key assumption made by those who believe we will grow out of deficit is that the economy in 2014 will look much like it did in 2004. But that assumption, a growing number of economists now say, could be a fatal one.
“It is critical to recognize that things will not simply return to how they were,” TD warns in its report jointly written by Derek Burleton, the bank's director of economic analysis, and Grant Bishop, a bank economist.
After crunching the numbers they conclude: “This longer-term “cruising speed” of the economy is set to slow from about 3 per cent per year on average over the past two decades to about 2 per cent per year in 2009-19. More specifically, we forecast a slump in Canada’s average annual potential growth to 1.6 per cent over 2009-2012 (the near-term “recovery” phase) with a return to only an average of 2.1 per cent across 2013-2019 (the “long-term”).”
You can read the TD analysis for yourself to test some of their assumptions behind this conclusion but I'm going to skip the economics and cut straight to some of their more important points:
First, the best kind of economic growth is produced by growth in productivity — producing more goods and services with the same number or fewer workers. For Canada, that kind of economic growth is crucial as our labour force ages, retires, and we have proportionately more retirees relative to workers.
“We do not see a compelling case for a major productivity resurgence, given Canada’s poor record on innovation. Slumping expenditures on research and development and low investment in high-tech capital by Canadian businesses appear the prime culprits for Canada’s lack of innovation and overall slowing of productivity growth,” TD says.
Indeed, the 'productivity problem' was the number one public policy issue that the recently retired civil servant mandarin Kevin Lynch identified early on his career, first as deputy minister at Industry, later as deputy minister at Finance, and, finally, as Stephen Harper's Clerk of the Privy Council.
Unfortunately, Lynch and other policy analysts who have ideas about doing something to boost productivity, run into retail politics. Cut the GST by two points? Great for retail politics. Lousy way to waste $15 billion a year of precious government revenue that does nothing to boost productivity and could, in fact, reduce it. How about lowering or eliminating capital gains taxes? Lousy retail politics as its framed by the left as a tax break for the rich. But policy analysts say it encourages capital formation and new investment which, in turn, creates jobs and boosts productivity.
TD doesn't come right out and say it but you can read between the lines of the penultimate paragraph in their report to conclude that tax policy going forward will be crucial, not only to eliminate government deficits, but to sustain Canada's economic growth:
“Governments cannot count on economy-wide, long-term nominal income growth much above 4%. Obviously, aggregate tax revenues can only grow above the pace of nominal income growth by seizing a larger share of nominal income. Current federal and provincial deficits must be addressed: curtailing growth in spending is essential, but, even if governments see no other option than a heightened tax share, they must resist pressure to retreat from those tax reforms that encourage productivity improving investments.”
That, my friends, is economist-speak, for: “Governments will need more tax revenue. But they can't tax capital formation. So that means, cuts on capital gains are important and low income taxes are also important. The best kind of new tax revenue, then, are more consumption taxes. So someone's going to have to bite the bullet and raise the GST.”

3 thoughts on “TD: Canada's economic "cruising speed" to slow post-recession”

  1. This is more of a question than a comment, but would the TFSA's that were introduced a couple years ago be considered a shield against Capital Gains taxes? I know, it's not eliminated the tax all together, and with it's $5000 annual contribution limit, it will hardly affect bigger investors, but wouldn't it have the effect of eliminating capital gains taxes on those who invest less than $5k annually?

  2. As you guessed TFSA's really don't do what a capital gains tax break would. Example: A serial entrepreneur creates a new business, hires people, does well and wants to cash out and take the gain on selling that business so s/he can fund the startup of another new business. In the U.S., the entrepreneur is not taxed (or less so) on the gain from the sale of the first business. In Canada, the entrepreneur pays a significant amount of tax. This tends to be a barrier to capital formation and to the creation of new businesses (and new jobs).

  3. As the name implies, TFSAs are essentially a savings vehicle. It is not designed to encourage investment, which as David points out a capital gains tax cut would do, but gives Canadians an alternative method of building up their savings.
    If you invest $5,000 (which comes from your after-tax income), then the investment grows tax-free and it is sheltered not only from capital gains tax, but also from tax on any interest or dividends received.
    With RRSPs on the other hand, the initial investment is tax-sheltered, so when you withdraw the money, you pay tax on it.
    It's really up to the individual as to which method is better, or whether some combination is the best way to go.

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