It’s hard to argue against tax cuts, as they are politically popular and economically stimulative. The latest round of federal tax reductions, however, are not the type that are likely to address the economy’s dearest need: improved productivity.

The fall economic update from federal Finance Minister Jim Flaherty includes both a healthy round of personal and corporate tax cuts and debt reduction. Certainly, the changes seem to be a shrewd political move. Broad-based tax cuts are likely to be popular with voters at a time when the government is enjoying large and sustained surpluses. It also allows the government to steal some political ground from its main competition, the Liberals, who are promising tax cuts of their own.

Analysts see the planned cuts as economically stimulative as well, which is important because the direction of the global economy remains uncertain, risk of a U.S. recession is looming and a strong Canadian dollar is undermining certain domestic industries.

The nature of the planned cuts, however, which are largely focused on consumption, means that the cuts aren’t likely to boost productivity or enhance corporate competitiveness as much as similar sized cuts on the income side could have done.

So, while Flaherty is following through on a Tory election pledge to cut the GST to 5%, effective Jan. 1, 2008 — a measure that may prove popular with voters — that hasn’t attracted much applause from economists. They would much prefer either corporate or personal income tax cuts to consumption-focused cuts.

Economists at Royal Bank of Canada call the GST cut “ill-advised,” noting that it may push some holiday season spending into the new year, boosting the case for a rate hike from the Bank of Canada because of the fiscal stimulus.

Similarly, a TD Bank Financial Group report calls the proposed GST cut “regrettable.” TD argues that the only way to make a GST cut economically redeeming would have been to tie it to harmonization of provincial and federal sales taxes. Ottawa intends to address the harmonization issue but, the TD report suggests, the time to do so is when the federal rate is being cut. That way, provinces that would suffer a revenue loss from harmonization could raise their rates without affecting consumers: “We, therefore, cannot help but feel that an important opportunity was missed to help make Canada more competitive on that front.”

The one group that should be happy with a GST cut is lower-income taxpayers. They will get the greatest benefit from the reduction. Similarly, the other planned personal cuts tend to favour lower-income families. Ottawa is proposing to reduce the lowest personal income tax rate to 15% from 15.5%, and it plans to increase the basic personal amount to $9,600, both retroactive to Jan. 1, 2007. Also, the basic personal amount will be increased to $10,100 at the start of 2009.

A reduction in the basic personal amount affects all taxpayers, and the cut to the rate paid by those in the lowest tax bracket obviously helps lower-income workers. But what the government hasn’t acted on is its other high-profile campaign promise: capital gains tax relief. Nor has it delivered anything to those who are holding out hope for broader income-splitting or new after-tax retirement savings accounts.

In his post-budget comments, Flaherty indicated that capital gains reform is still in the works. After all, this was only an economic update, not a full-blown budget. While these events are increasingly being treated like mini-budgets, more intricate measures may have to wait for a full budget. This time around, Ottawa appears intent on delivering some universal tax relief, whereas its budget measures have often been much more targeted.

Similarly, on the corporate side, the government is promising a few broad cuts. It is proposing to reduce the general corporate income tax rate to 15% by 2012, starting with a one-percentage-point reduction in the rate in 2008 to 19.5%. It also plans to reduce the small-business income tax rate to 11% in 2008, one year earlier than scheduled.

National Bank Financial Ltd. notes that Ottawa is also hoping to get the provinces onside, with the goal of bringing the combined statutory corporate income tax rate to 25% by 2012, which would be the lowest among the G-7 countries.

@page_break@In the meantime, analysts are pleased to see some form of corporate tax relief. Desjardins Secu-rities Inc. notes that the fact that corporate tax rates are going down will boost Canadian corporate profitability. It suggests that the planned tax cuts should be enough, by themselves, to eliminate the gap between the return on equity for the S&P/TSX composite index and the ROE of the S&P 500 composite index. “Tax cuts in Canada should be stimulative to the Canadian micro and macro economies,” add the Desjardins analysts, “and will probably help Canadian markets to continue to outperform.”

The TD report cautions that the planned corporate tax cuts are mostly back-end loaded. Nevertheless, it says, they should “place Canada on a better competitive footing” relative to other economies.

In addition to the tax cuts, Ottawa will devote another $10 billion to debt reduction in the current year. It now forecasts lowering the debt/GDP ratio to less than 25% by 2011-12, which would be three years ahead of schedule.

Federal finances are expected to remain in surplus, but there probably won’t be much room to move in the next full budget, either in terms of boosting spending or by significantly reducing taxes. The TD report says that the planning surplus is likely to be less than $2 billion until the 2010-11 fiscal year. That may temper the hopes of those holding out for major capital gains relief.

This recent economic update is also disappointing to those hoping for more meaningful corporate income tax reductions. As the RBC report notes, three-quarters of the cuts are personal measures rather than business ones, and three-quarters of the personal cuts are targeted toward consumption, not income: “A total of $60 billion in new tax relief has been offered to households and businesses over six fiscal years. However, the fact that three-quarters ($45 billion) of this is focused upon personal relief will disappoint those who point to Canada as being in line with the OECD average on personal taxes, but much less competitive on business taxation once provincial tax rates are included (especially Ontario).”

A report by economic research firm Global Insight Inc. adds: “The package is politically astute and does represent a significant cut in the overall tax take. Whether the measures are optimally designed to encourage economic growth is another matter.” Its research suggests that GST cuts are not stimulating consumer spending noticeably.

Moreover, the cuts, the bulk of which some economists see as ill-advised, come at a time when public spending is hefty and revenues are inflated by high commodity prices. “Prudent government planning this is not,” says an HSBC Securities (Canada) Inc. report. “Rather, Canada is the beneficiary of an extended commodity boom that has filled government coffers.” It adds that the cuts are coming at a time “when program spending has been accelerating wildly.”

Despite the negative reaction to the proposed cuts, there aren’t many complaining about the idea of tax relief. The measures are being applauded by financial services lobby groups, such as the Canadian Life and Health Insurance Association and the Canadian Bankers Association.

There are also some economists who take a kinder view of the government’s effort. The NBF report says that the combined personal and corporate tax cuts should provide a long-lasting fiscal boost to the economy: “Although some argue that the GST reduction is not the optimal tax cut, the proposed $26 billion in corporate and income tax reduction over the next five years will improve Canada’s competitiveness in the global economy.”

Similarly, economists at Bank of Montreal say that the cuts “could provide a much-needed boost to the economy next year, when it will face the brunt of the mighty loonie’s latest surge.” The BMO report allows that the measures reduce the potential for interest rate cuts, “though the economy may still weaken sufficiently to spur a modest rate decline.

“The tax relief could weigh on bonds, though planned reductions in the public debt are a long-run plus,” the BMO report adds. “The tax cuts are also a boon for the loonie and the equity market.” IE