The slim minority won by the Conservatives should keep Ottawa paying down the debt, but spending and tax cut plans will have to be finessed through a divided House of Commons, suggest Bank of Nova Scotia economists, in a new report.

“The most notable common ground with the Liberals is the Conservatives’ pledge to keep the federal books balanced, earmarking at least $3 billion for annual debt repayment. Consequently, Ottawa should remain on track to lower net debt relative to GDP to the revised target of 20% by 2020,” it predicts.

“In terms of spending plans, the Conservatives echo some Liberal priorities, such as post-secondary education, emphasize other areas such as defence, and propose significantly different approaches for a number of programs such as child care,” Scotia says. “Critical to the Conservatives’ working relationship with the Bloc Québécois is their pledge to revisit federal-provincial financial arrangements and address the current fiscal imbalance.”

It notes that the Conservatives indicated that they will follow through with the corporate tax reductions proposed by the Liberals last November. This includes removing the capital tax for larger non-financial corporations in 2006, eliminating the corporate surtax in January 2008 and trimming the general corporate income tax rate from the current 21% to 19% from 2008 to 2010.

The Conservatives and the Bloc both support the enhanced dividend tax credit introduced last November, it notes, and the Conservatives have pledged not to impose new taxes on income trusts. Its proposal to defer the capital gains tax for individuals on the sale of assets if the proceeds are reinvested within six months requires further detail, it notes.

“Trade-offs are likely as the Conservatives implement a key plank in their election platform — dropping the Goods and Services Tax rate from 7% to 6% in the near-term, and eventually to 5% over the next five years,” it predicts. “The immediate cost of the GST relief will be difficult to afford given the expense of the personal income tax reductions introduced in the November Update, retroactive to 2005.”

“Drafting a first budget will undoubtedly involve some careful balancing,” Scotia suggests. “Since 1944, only three governments have moved from election to the first sitting of Parliament within 42 days, but this still leaves open the possibility of a budget this spring.”

“Tax cuts remain on the table and will continue to provide some insulation for domestic consumption in the face of continuing headwinds, though not enough to produce overheating conditions,” Scotia predicts. “Hence, the climate is also one of status quo for the Bank of Canada, which is expected to remain on course for additional tightening beyond today’s much-anticipated quarter-point hike. Ditto for the Canadian dollar.”

“While immediate reaction by the market was negative on the news that there would not be a majority government, the impact of the election is swamped by other more important fundamentals. Rising oil prices, on the back of heightened Middle East tensions, a shift by foreign investors away from the U.S. dollar and the potential uncertainty accompanying this month’s change in Chairmanship at the Federal Reserve will have a greater influence on currency direction in the weeks and months to come. Again, with the popular support for the Bloc down well below 50%, foreign exchange markets are expected to deem this a positive over the medium term,” it concludes.

http://www.scotiacapital.com/English/bns_econ/special0124.pdf