The first budget of the Canadian prime minister Paul Martin’s Liberal government features a host of bold future spending commitments and, to appease the other parties, something for basically everyone in the interim. But how much it offers foreign investors is open to debate and some members of Canada’s business community are worried that the proposed budget does not go far enough to keep the country competitive.

“The Canadian government does not understand that we must compete in a globally competitive environment; our tax incentive circumstance is a big negative for our future economic prosperity,” says Bill Lawson, an associate professor at the Eric Sprott School of Business at Ottawa’s Carleton University. “We will fall further and further behind, far below our country’s potential.”

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The Canadian Manufacturers & Exporters Association (CME) did not appear impressed with the budget. “After building up expectations that the federal government would address the challenges facing Canadian industry, the few measures introduced in this year’s budget fall far short of what is necessary to boost investment, production, jobs or export performance,” says Jayson Myers, CME’s senior vice-president and chief economist.

The budget had a stormy reception in parliament but has gone to the third reading and is expected to pass.

The government has a lot going for it. As a result of Canada’s seven consecutive surpluses, the country has moved from having the second worst debt-to-GDP ratio in the G7 to having the best. And a 2004 KPMG study of international business costs in 11 countries showed Canada’s costs were the lowest.

Canada has continued to attract more than its fair share of global greenfield FDI. In the past 10 years, it has attracted about 6% of the global total, far more than its share in the world economy, which is less than 2%.

The government’s strong fiscal position and lower debt burden have meant more resources are available to spend on pressing problems like healthcare, defence and Kyoto commitments, while maintaining the country’s corporate tax advantage relative to the US. Once the measures in the 2005 budget are fully in place in 2008, the corporate surtax – originally introduced to help fight the federal deficit – will be eliminated and the general corporate income tax rate will be reduced to 19% from 21%.

Spending growth

The reaction from the business community was generally favourable. “The biggest concern for business leaders is the overall rate of spending growth,” says David Stewart-Patterson, executive vice-president of the Canadian Council of Chief Executives (CCCE), which represents the heads of about 150 leading domestic companies. “Much of the new spending is going to meet very important priorities, from improving healthcare to strengthening our armed forces. But overall programme spending is up by 12% this year and has grown 44% over the past five years.”

However, questions remain about whether the government will able to afford everything that it has promised. Some business leaders are fretting over the sustainability of its stated commitments to spending on social programmes. And, ironically, the strength of the Canadian dollar presents risks to the country’s economic health.

“I’ve said very clearly that the value of the dollar is one of the budget’s downside risks,” Canada’s finance minister, Ralph Goodale, has stated.

The CCCE, though, is slightly consoled by the finance minister’s “continued bedrock commitment to balanced budgets, prudence in fiscal forecasting and the dedication of unused contingency funds to debt reduction”, says Mr Stewart-Patterson.

Competitive position

But the key question, at least in terms of FDI, is whether the budget goes far enough to maintain Canada’s global competitiveness.

Mr Stewart-Patterson says he is glad that the government seems to have recognised the importance of a competitive tax regime, and in particular of keeping Canadian corporate income tax rates significantly below those in the US in order to attract more investment and jobs. But he tempers this by adding: “These improvements, however, offer little comfort in the short term to Canadian exporters that are trying to cope with the rapid rise of the Canadian dollar over the past two years and which need to make major investments now to stay competitive and continue growing from a Canadian base.”

According to the CME, the government’s competitiveness agenda is taking too long to implement. “Bottom line: this is an election budget. There are a lot of back-end measures that will not take effect for years,” says Mr Myers.

“As a business association, we were advocating a five-year tax strategy, but that does not mean that the government has to wait five years for the measures to take effect.”

The CME believes that, in addition to the tax breaks, some very limited tax and spending measures will be of benefit to industry. “But the government’s failure to accelerate depreciation allowances for manufacturing equipment is a major disappointment,” Mr Myers says. “It is clear from this budget that, while the government is willing to spend heavily on one hand, and use the tax system for environmental policy purposes on the other, it just doesn’t get it when it comes to building a competitive investment environment in Canada.”

Defence argument

The Department of Finance, not surprisingly, defends the budget. “The government has taken significant action in recent years to reduce taxes for Canadian families and businesses,” says a Department of Finance spokesperson in response to Mr Myers’ critique. “Tax reductions have been part of a balanced approach that includes reducing debt and investing in key programmes for the benefit of Canadians. Therefore, tax reductions have to be sustainable and fiscally responsible.”

The $100bn Five-Year Tax Reduction Plan introduced in 2000 reduced federal personal income taxes by 21% on average, and by 27% for families with children. It also reduced the general corporate tax rate to 21% from 28% which, the Department of Finance says, levelled the playing field for Canada’s service sector and created a tax advantage for investment in Canada.

“Budget 2005 builds on the government’s strong record of sustainable, responsible tax reductions with further personal and business tax reductions,” the spokesperson insists.

Pensions boost

In a surprise move, Canada has abolished limits on how Canadians invest their retirement savings, opening a whole new ballpark for many pension funds to contribute to Canada’s stock of outwards investment.

The federal budget’s scrapping of the 30% limit on foreign content – for pension funds and individuals alike – is “a victory that, quite frankly, we were not expecting”, says John Murray, vice-president of regulation and corporate affairs for the Investment Funds Institute of Canada, a Toronto-based industry association. “We had hoped the government might reduce the restrictions incrementally. We are very pleased with the results,” he says.

According to the budget, the rationale for the government’s move is: “As Canadian markets have grown and matured since the early 1990s and become more integrated with global capital markets, access to capital for Canadian companies has improved substantially.”

The limit, set at 10% in 1971, rose to 20% in the 1990s, then to 30% in 2001. Investors who exceeded those limits were penalised with a 1% per-month penalty tax.

The clear winners are Canada’s pension funds, which until now have been crimped by the relatively small domestic market in which they had to operate. The Canadian stock market accounts for only 3% of world stock market capitalisation.

The Conservative party has come out swinging over the budget, even threatening to trigger a snap election in the spring. With the Liberal government in a minority, a vote against the budget by the Conservatives would count as a vote of no confidence, which would require another election to be held. Opposition leader Stephen Harper later backed down from this position. Whatever the fate of the budget, the government’s business competitiveness agenda and tax regime are unlikely to see any large-scale changes any time soon.

Some members of the business community think that is a shame. Carleton University’s Professor Lawson has some unambiguous advice for the government: “The message is not getting through: lower taxes to stimulate the private sector’s wealth, creating capacity, resulting ultimately in more tax revenue. Stop with the short-term politicking and adopt policies for the long term.”

 

 

R&D INITIATIVES

Canada’s proposed budget provides $810m in strategic investments in ideas and enabling technologies over the next five years. These include:

  • $375m over five years for the three federal granting councils: the Canadian Institutes of Health Research, the Natural Sciences and Engineering Research Council of Canada, and the Social Sciences and Humanities Research Council of Canada.

 

  • Increasing funding to universities and research hospitals for the indirect costs of federally sponsored research, bringing the total to $260m a year from $245m starting in 2005-2006.

 

  • $125m over five years for world-leading particle physics research at the Tri-University Meson Facility (TRIUMF) science facility in British Columbia.

 

  • $30m for the Canadian Academies of Science to provide independent expert assessments of the science underlying key issues.

 

  • $165m for Genome Canada in support of breakthrough genomics research.

 

  • $20m for Precarn, which specialises in advanced robotics and artificial intelligence.

These initiatives build on the $11bn added by the government of Canada for university-based research since 1998.