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Peace Tower on Parliament Hill, Ottawa (Sean Kilpatrick)
Peace Tower on Parliament Hill, Ottawa (Sean Kilpatrick)

Two ways to cure the deficit - and both are painful Add to ...

Whoever forms the next government faces a harsh and inescapable hangover: The deficit left by the recession is one that won't be cured without the tough medicine of spending cuts or tax hikes - or both.

As his government fell Friday, Stephen Harper declared that the economy has been, and will continue to be, the top priority of his Conservative Party, which earlier in the week unveiled a budget that promised to wipe out the deficit within four years. The Liberals, whose historic no-confidence motion toppled the Tories, also vow fiscal austerity.

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Observers don't buy the Conservative pledge to do it all merely by squeezing efficiencies out of government operations. After all, no government has ever managed to keep spending below the rate of inflation for very long. Canadians have yet to see the plans of the other parties as the campaign begins.

Few economists expect the fourth federal election in seven years - now expected as early as May 2 - to significantly knock off course the steady downward track of Ottawa's deficit, projected to be $40.5-billion in 2010-11. It's a question of how much more is needed to get it done.

"The only way you address this is through serious revenue enhancements … or reductions in transfers, which is principally health care," said Ian Lee, MBA director at Carleton University's Sprott School of Business.

The Conservative plan, laid out Tuesday by Finance Minister Jim Flaherty, would eliminate the deficit by keeping a lid on everything the government spends and then watching revenue surge along with the recovering economy. In his budget forecast, the shortfall would shrivel every year until it blossoms into a $4-billion surplus in 2015-16.

The bottom line for whoever takes power is that real cuts to transfers or programs, or higher taxes, or even a combination of both, will be needed. The task is doable, but there will be pain.

The expenditure side: When Canadians think of cutting government fat, they imagine hundreds of overpaid bureaucrats sitting around doing little of substance. The reality, however, is that more than 60 per cent of the money Ottawa spends is through transfers to people (the elderly, the unemployed and children) or transfers to other governments (equalization payments and health-care transfers).

And these transfers are rising fast. Transfers for health care, for example, have a built-in 6-per-cent-a-year escalator clause. Employment insurance payouts will decline as the economy recovers. Left unchecked, the cost of pretty much everything else is headed higher.

Over the past few years, all government departments have produced efficiency savings. The Conservatives insist there are still more savings to be squeezed through another sweeping review of federal spending - up to $4-billion a year.

Remove debt-service costs and departments deemed untouchable, and there's not much left to chop.

"The law of diminishing returns quickly takes over," pointed out Jeremy Leonard, research director at the Institute for Research on Public Policy in Montreal. "So I'm not holding out much hope for that."

That doesn't mean there aren't major savings to be wrung out of spending. Mr. Leonard, for example, suggested that reforms to the Canada Pension Plan could achieve the dual goals of saving money and encouraging older workers to stay in the work force longer. Ottawa could do that by reducing benefits for those who take early retirement, while boosting benefits for those who retire after 65. Mr. Leonard said that could produce several billion dollars in savings.

"That's going to help economic growth and help older Canadians achieve what they want to do," he said.

Much larger savings could be had by trimming transfers to the provinces. Transfers for health and social services ($37.2-billion a year) are set to rise at roughly 6 per cent a year under current agreements. Carleton's Mr. Lee said annual increases of 4 per cent when those deals expire at the end of 2013 would save billions.

"I don't think strategically, fiscally or politically that any government - Liberal or Conservative - can sign an agreement with a 6-per-cent escalator when the economy isn't growing at 6 per cent a year," Mr. Lee said.

Ottawa also hands out billions of dollars in loans and grants to businesses. The IRPP's Mr. Leonard suggested that if Ottawa is cutting corporate income taxes, there's a case to be made that it should curb direct subsidies.

"I'm not so sure why we are cutting their taxes while they're still getting these big subsidies," he said.

The government could also jettison Crown corporations, such Canada Mortgage and Housing Corp. or the Export Development Corp. This wouldn't save Ottawa much money, because most of these are profitable or self-sustaining, but it would result in sizable one-time gains.

The revenue side: The Conservative budget projects that its tax bite will rise 4-6 per cent annually over the next four years, based almost entirely on the steadily improving economy.

The Liberals have promised to scrap next year's plan to lower the federal corporate income tax. That would save nearly $4-billion. The Conservatives, on the other hand, argue that tax cuts pay for themselves by encouraging companies to grow and hire.

There are other options. Reversing the Conservatives' earlier cuts in the goods and services tax would bring in billions more.

"It's inevitable that we are going to see a GST increase down the road," Mr. Lee said.

Most economists concede now probably isn't the time, however, with the recovery still fragile and consumers nervous.

There is another way. They're called tax expenditures - credits, deductions and the like. Ottawa delivers tens of billions to Canadians this way. Tightening them up or eliminating some of them altogether could produce substantial revenue gains.

The latest Conservative budget, however, would have added several new ones, including credits for volunteer firefighters, caregivers and parents of children in arts programs.

The IRPP's Mr. Leonard suggested that a review of the dozen of tax breaks and loopholes for businesses could produce billions in new revenue. The Scientific Research and Experimental Development credit ($3.5-billion a year) would be a likely target to tighten up, he said.

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