Some business groups are calling for a reduction in personal income taxes in the next federal budget, but most economists suggest that Ottawa won’t have the money.

Such reductions would be expensive. An across-the-board, one-percentage-point cut in personal income tax rates would cost about $4 billion, says Don Drummond, chief economist at TD Bank Financial Group in Toronto.

On the other hand, the federal government could provide some tax breaks targeted toward low-income groups. It might provide some corporate tax reductions aimed at increasing productivity, although that won’t include the corporate income tax cuts killed as a result of the agreement with the New Democratic Party that allowed the 2005 budget to pass.
The Liberals had previously said these cuts would be restored, but with a federal election looming early next year, word is that the cuts are on the shelf.

Meanwhile, political pressure for personal tax cuts is rising. The Canadian Chamber of Commerce is urging such reductions.

There’s good reason. Personal income taxes as a percentage of personal income are estimated at 9.6% this year vs 9.1% two years ago. This figure will reach 10% in fiscal 2010 unless rates are cut, says Dale Orr, managing director of Toronto-based Global Insights (Canada) Ltd. , an economic consultancy based in Toronto. Real incomes are expected to rise, pushing more and more people into higher tax brackets each year.

The Liberals don’t want to be known as the government that increased the personal tax burden, says Orr. With a federal election pending for the spring, there is a feeling the government might announce its intention to reduce personal income taxes “when fiscally feasible.”

But affordability remains the issue. Monte Solberg, the federal Conservative Party finance critic, says his party would reduce program spending to make room for tax cuts.

Economists concur that, although federal budgets in recent years have vastly underestimated how much money is available, there really isn’t much to play around with. Bank of Montreal, Bank of Nova Scotia, TD, the C.D. Howe Institute, Global Insights and the University of Toronto’s Institute for Policy Analysis all say that broad-based personal income tax cuts are not affordable.

Economists don’t have specific figures on how much money they think will be available because they’re processing Ottawa’s final numbers for fiscal 2005 before updating their forecasts. (The fiscal year ended on March 31 but the final numbers weren’t released until Sept. 21.)

Economists doubt there will be more than a few billion dollars for this year and next — beyond the money put aside for contingency reserves ($3 billion each year) and economic prudence ($1 billion in fiscal 2006, $2 billion in 2007, $3 billion in 2008, $3.5 billion in 2009 and $4 billion in 2010).

This isn’t really a surprise. The Liberals have been ramping up program spending faster than the increase in gross domestic product in each of the past four years, and budgeting a big 11.8% rise for this year.

The resulting shrinkage in fiscal capacity was evident in February’s budget, in which a lot of the spending and tax cuts were targeted for three, four and five years in the future.
This includes the reduction in corporate income tax rates that were shelved in order to get NDP support to pass the budget.

Drummond also points to pressure on the Liberals to level the interprovincial playing field, which has gotten out of whack with special deals to particular provinces —such as the $5.75-billion pact with Ontario announced in May, which will provide support for immigrants, training for the unemployed, for post-secondary education students and institutions, and for climate change projects.

Rick Egelton, chief economist for BMO, thinks there may be something for defence and/or foreign aid.

As a result, economists and analysts expect only modest personal income tax relief aimed at low-to mid-income earners. This could take the form of a rebate or tax credit to help with high heating and gasoline prices, which would be clawed back as income increases.

If relief is provided through rebates, that would raise already high marginal tax rates for certain middle-income earners. When these taxpayers reach the point where the clawbacks hit, Drummond says, they would suddenly be paying a very high rate on the extra income, often 60%-70%. One partial solution would be to make clawbacks more gradual, he says.

@page_break@Meanwhile, Finance Minister Ralph Goodale’s current focus is on raising Canada’s productivity growth, which has been lagging the U.S.’s since the mid-1990s. Personal tax cuts should be part of that, as lower taxes would encourage work and savings.

But corporate tax breaks are also needed. It’s unfortunate that the corporate tax breaks won’t be reinstated in the next budget; but if they are brought in after the election, not much would be lost. The proposed cuts include elimination of the capital tax by 2008, starting in 2006; a reduction in the general rate to 19% in 2010 from the current 21%, starting in 2008; and elimination of the corporate surtax as of 2008.

What Goodale might do is increase capital cost allowances. Finance has reports showing that economic depreciation of assets is much higher than previous Statistics Canada estimates suggested, says Jack Mintz, president of the C.D. Howe Institute in Toronto and former chairman of the Mintz committee on business taxes. For example, buildings were presumed to depreciate at 2%-2.5% a year and are now estimated to depreciate at 5% a year. There are similar increases for many types of machinery.

One possibility, says Mintz, is to increase capital cost allowances for manufacturing plants; there are serious concerns about the competitiveness of that sector in Canada.

As well, there could be spending initiatives aimed at increasing productivity, says Orr:
“A lot can and should be done on program spending.” This is likely to include education and training, support for R&D and infrastructure, such as improving trucking routes and cross-border crossings.

Another possibility is a new investment tax credit, says Peter Duggan of U of T’s Institute for Policy Analysis. New capital investment is key to increasing productivity, he points out, and many other countries provide such tax breaks.

Finally, there are income trusts. If too many more high-profile companies say they considering going this route, Ottawa may be forced to act quickly (see page B17). IE