The first budget of Stephen Harper’s minority Conservative government fulfilled major election promises, including the one-percentage-point cut to the GST and the $1,200 grant to families per child under six years of age, as well as more money to the provinces and for defence.

Although this didn’t leave a lot of room for other measures, there were some notable ones. Many economists applauded the decision to accelerate the corporate tax cuts initiated by the former Liberal government and approved retaining part of the Liberals’ tax cut to the lowest personal income tax bracket.

However, the economists didn’t like the introduction of more tax credits (for children’s fitness, public transit passes, textbooks, apprenticeship and tradespeople’s tools), particularly if it’s a sign of how the Conservatives plan to proceed on the tax side. Canada’s tax system is already too complex, and more credits just make it more so.

Economists also don’t likethe GST cut because it encourages consumer spending, which does nothing to enhance Canada’s long-term economic potential. Personal income tax cuts, on the other hand, encourage working more, saving and investment, and can increase productivity, which increases Canada’s growth potential. Unfortunately, the Conservatives have already promised another 1% cut to the GST in the next five years.

On the positive side, the Tories have moved quickly on corporate tax cuts. The elimination of the capital tax by 2008 is particularly welcome, as that is considered the tax that is the most negative in terms of encouraging companies to expand, invest and locate in Canada. The reduction in the corporate income tax rate to 19% from the current 21% by 2010 and in the small-business tax rate to 11% from 12% by 2009 — with an increase in the threshold to which it applies to $400,000 from $300,000 — should also encourage investments that increase productivity.

The Conservatives also increased the dividend tax credit for large corporations, as the Liberals planned to do. Although this is aimed at discouraging more income trusts, it’s welcome as an enhanced incentive for buying Canadian equities.

The budget only went out two years — which is reasonable, given the Conservatives’ minority government position and the short planning time following the January election. It does not, though, give much indication of the Conservatives’ long-term plans.

The next budget presumably will reveal more about how the Conservatives will proceed. A major question is Canada’s position on the Kyoto protocol. The Conservatives already have said they won’t spend money buying international credits to meet the commitments made by the Liberals because it does nothing to reduce emissions in Canada. Instead, they will introduce measures to reduce emissions here. The tax credit for public transit passes is part of this, but what the rest will be, and what it will cost, is unknown.

On the tax side, it’s doubtful the Conservatives will jettison the promised future cut in the GST, but they may be able to find money to cut personal income taxes some more. It’s also possible they’ll initiate a review of the tax system, with the aim of simplifying it.

More tax cuts are premised on sufficient fiscal capacity, and that’s problematic. The Conservatives are expected to provide more money to defence and have promised to redress the federal/

provincial fiscal imbalance, which means giving more money to the provinces. If delivered, this could tie the government’s hands.

Federal/provincial negotiations tend to be lengthy, and probably will be particularly so in this case because the equalization program is also up for renewal. The Conservatives have promised to remove non-renewable resources revenue from the calculations, which could be vigorously opposed by some provinces. It’s quite possible there won’t be a resolution before the next federal election — in which case, it could be an election issue.

The easiest way to deal with fiscal imbalances would be to transfer tax room to the provinces and design a new equalization program from scratch. The current one, like the tax system, has become very complex over the years. Entitlements are based on revenue from only five provinces, and special deals have been struck with Newfoundland and Labrador, Nova Scotia and Ontario. And even though this last arrangement doesn’t affect the program directly, it is related because it gives Canada’s biggest province more money for other programs to make up partially for the huge amounts Ontario contributes to equalization.

@page_break@Economists would have liked to see the GST cut treated as a transfer of tax points, but that’s unlikely. Harper promised a tax cut and, with only a minority government and probably no more than two years before another election, he can’t afford to be seen as reneging on that promise. Provincial premiers would paint him as a promise-breaker if he told them that he’d fulfilled at least part of his promise to fix the fiscal imbalances through the GST tax cut because the provinces could now raise their sales taxes without making taxpayers less well off than they were previously.

Further examination of the federal books may identify possible savings in program spending, although the Liberals have already cut a lot of fat. Killing or reducing programs is another option, but a difficult one for a minority government. It’s unlikely the Tories could find support among the other parties, and even attempting to do so could be seen as very negative heading into the next election.

The fiscal picture in the budget is very similar to recent Liberal budgets. That is, projections show only small surpluses if the $3 billion for debt repayment is excluded. The “debt repayment” is a new name for the Liberals’ contingency reserves, which were always applied to reducing the debt if they weren’t needed for unexpected expenditures. The same procedure will apply to the debt repayment monies.

The Conservatives are, though, doing without the economic prudence reserves that the Liberals included in their budgets, so they may have to scramble if economic growth and, thus, revenue are lower than anticipated.

Many analysts heralded the budget as the dawn of a new era, given its emphasis on tax reductions and relatively modest spending increases. But it must be noted that the Liberals were also planning a lot of tax cuts if elected. Furthermore, they had a history of forecasting relatively modest spending increases of less than the projected growth in gross domestic product. It was only because they found themselves with unexpected surpluses that program expenditures ended up rising significantly.

To their credit, the Conservatives are trying to guard against the temptation to spend windfalls. Like all governments, they will face pressures from within their own party to spend excess funds on a wide variety on worthy initiatives. So, the Tories are proposing the “pre-allocation” of part of any unexpected surpluses. The budget said the feds will discuss with the provinces the possibility of putting part of any windfall toward the Canada and Quebec pension plans.

How successful such pre-allocations will be remains to be seen. One question is how much will be pre-allocated. But the key to success will be what ends up being labelled an unexpected windfall and what is deemed a necessary, even if unanticipated expense. IE