Bay Street economists are applauding the raft of tax cuts proposed in yesterday’s mini-budget, lamenting the silence on the trust issue, and wondering whether rate hikes might have to quicken to dampen the fiscal stimulus. Although, they note it’s uncertain whether any of it will pass.

RBC Capital Markets says that yesterday’s traditional Economic and Fiscal Update was generally viewed as a mini-budget. It notes the government is forecasting a budget surplus of $8.2 billion in the current fiscal year, rising to $11.3 billion by fiscal 2010-11.

“The government would commit to lowering the debt-to-GDP ratio from 38% currently to 20% by 2020. Personal income tax cuts were announced that would be retroactive to January 1, 2005. Corporate tax cuts were also announced along with increased spending on education and research and development intended to help boost productivity in the economy,” it reports.

However, RBC observes, “These initiatives are not guaranteed to pass since the opposition parties are threatening a non-confidence motion this week that could force Parliament to dissolve, thus ending the short life of this document.”

“The stormy political backdrop in Ottawa prompted Finance Minister Ralph Goodale to put some real meat on the bones of [the update],” says BMO Nesbitt Burns. On balance, the net new stimulus will add roughly 0.1 percentage points to GDP growth in the year ahead, it estimates.

“This will support GDP growth of close to a 3% underlying trend, and keep the pressure squarely on the Bank of Canada to keep grinding interest rates higher,” Nesbitt adds. “Yet again, we find a mild conflict between monetary and fiscal policy in Canada — just as the Bank is concerned that the economy is already operating close to capacity, threatening to boost inflation pressures, the federal government is opening the stimulus taps. This combination of a looser fiscal policy and a tighter monetary policy would typically be a big positive for the Canadian dollar, although political uncertainty looks to overshadow economics for the currency markets over the near term.”

As for the personal tax cuts, Nesbitt says, “Our only question to these tax cuts is: what took you so long?” Also, the government plans to reintroduce the corporate tax cuts which were initially unveiled in the 2005 budget. This would see the current 21% rate trimmed in three stages, starting in 2008, to 19% by 2010. “As well, perhaps the biggest positive is the planned move by Ottawa to advance the elimination of the capital tax,” it adds.

“Today’s program is welcome. It looks fiscally responsible, as the fiscal relief is far from exhausting future surpluses, even after subtracting allocation for contingency reserve and economic prudence. It confirms the fact that Canadians were just paying too much taxes, and today’s budget at least addresses the issue,” notes National Bank Financial. “Also, for many Canadians, especially Quebec and Ontario residents, this measure partially offsets the wealth transfer occasioned by the increase in energy prices.”

NBF notes that, “No announcement has been made regarding income trusts and dividend income taxation. It seems that Bay Street will have to remain in the dentist chair until after the election to know what will happen with income trusts.”

“Boosting competitiveness and productivity in an environment where the Canadian dollar is expected to continue appreciating and one where emerging market competition will become even more of a dominant fixture, will require more attention to corporate taxation than what was addressed here,” says Scotia Economics. “That looks to be off the table for the time being, possibly because it goes straight to the issue of income trusts.”

“Other than year-end tax planning, the government’s plan for the trusts is the most important topic going. Everyone from Mr. Claus down to Kirby the elf has been looking for a solution to the uncertainty over trusts, if not making a holiday wish for a recovery of the over $20 billion reduction in capitalization since September, but the Finance Minister’s plan for the consultation period to extend to December 31st precluded any measures on the subject in today’s statement,” Scotia says.

It wonders whether all of these tax cuts and spending increases leave enough fiscal room to deal with the trust issue by cutting dividend taxes. “ If we were to start lowering the federal corporate income tax rate from the current 21%, with a cut of at least 2 percentage points effective January 1st of 2006, there would still be room for more generous dividend taxation,” Scotia concludes. “Some may argue that such measures would have been probable in a situation where the government wasn’t facing an immediate election, where a more ‘equitable’ split could be made between corporate and personal tax measures, however, in the current scheme of things, the trust issue could have been left in a worse state.”

@page_break@CIBC World Markets agrees that, “post-election, whatever the outcome, there will be room for the federal government to lighten up on taxes while staying on course for small budget surpluses.”

“It’s doubtful that the bond market will be at all taken aback by any implications of this statement in terms of bond supply,” it adds. “Note that the end result is that Ottawa is essentially maintaining its recent policy of planning for small surpluses, using economic growth to reduce the debt-to-GDP ratio, and devoting anything left over for new spending or tax cuts. There were no expectations of a return to mega-billion surpluses. Canada will still be alone in the G-7 in heading for budgetary black ink, and its overall net debt/GDP ratio including the provinces is already below the comparable (and growing) figure for the US.”

NBF agrees with Nesbitt’s assessment of possible monetary policy implications, saying, “With the Canadian economy already operating at capacity, this budget, if implemented, could lead the Bank of Canada to adopt a more restrictive policy stance to maintain the balance between aggregate demand and supply that will be needed to keep inflation on target.”

However, CIBC notes, “In terms of economic growth, remember that the prior year also saw substantial fiscal stimulus, and it’s only the acceleration in the degree of stimulus that would affect growth and the need for the Bank of Canada to provide an offsetting tightening.”

However, whether these measures are implemented remains a big question. “Although some of the announced personal tax cuts will be retroactive to January 1, it is quite possible that none of these measures will be passed into law, given the tenuous state of the minority government,” BMO Nesbitt points out. “With these tax cuts, the promised federal home-heating relief, and the applause from Canada’s corporate sector, the Liberals are daring the Conservatives to vote them down. The opposition would then stand accused of taking cash out of the pockets of Canadians, and branded as the grinches who stole Christmas.”

“The money bills will likely be tacked onto the government’s supplementary estimates bill that is coming to the House on December 8, but the Liberal government might not last that long,” Nesbitt suggests. “The NDP are still set to bring a motion tomorrow calling on the Liberals to commit to calling an election in early January, for a vote in early February. This would allow these tax cuts to be introduced. However, if the Liberals refuse to concede to call a February election, the weekend agreement between the opposition parties calls on the Conservatives to introduce a non-confidence motion on November 22 or 24. The Liberals have pledged to vote against the bill bringing forward the election, and effectively scotching these tax cut proposals—for the time being.”