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  • KPB & Co Research

Over the last 2 to 3 months, the liberals have been very vocal about their focus for the 2019 fiscal budget. In a recent interview, finance minster Bill Morneau outlined that the key pillars of Canada's 2019 budget will be affordable housing, skills training, and reducing the cost of medicine. Going into an election year one would not expect the government to make unpopular political decisions, on the other hand, the government has enough fiscal room to address the long term structural issues that affect Canada's competitiveness. This is not to undermine the importance of the issues that the liberals have brought up. Sky high real estate prices, together with rising interest rates, and tougher mortgage requirements have made it challenging for Canadians to own a home. Low cost for prescriptions drugs is a basic human right, and Canada has long suffered from a skills gap. However the long term competitiveness of Canada is just as important and it can be greatly improved through tax incentives, faster infrastructure spending, and more foreign investment.

Lower Personal & Corporate Taxes Needed For Upcoming Challenges

Recent economic data point to a slowdown of activity globally and particularly in Canada's major trading partners, a trend that lower taxes can counteract. US manufacturing index is showing signs of weakness, and GDP growth in China slowed further in Q4 of 2018. Canada is at a higher risk of facing a severe downturn than most as personal debt among households is high.

As the Central Bank of Canada and the US Federal Reserves look to tighten monetary conditions further, the pressure on households will intensify and will undoubtedly lead to slower consumer demand. Companies will also face harder times. Today business optimism in Ontario is improving, but it is still below where it was in 2014. While a clearer picture about economic policy contributed positively to confidence, much of that was offset by concerns about competitiveness. Alberta's economy is on the ropes due in part to a pipeline capacity shortfall in the region, and low oil prices globally. The liberal government's initiative to cut oil output has led to some stability in prices for Canadian crude, and the follow on initiative of the Government of Alberta to expand crude by rail will help in fetching better prices. However, the global outlook for oil is still benign as there are billions of barrels of oil supply waiting on the sidelines to be reactivated. Overall, the picture for 2019 is not great, a fact that is reflected in the outlook provided by economists across all banks.

Canada Economic Forecasts By Major Bank

Lowering taxes will not Blow Up The Budget

Lowering personal and corporate taxes is stimulative for the economy, and the government has the wiggle room do it. The general government carries a deficit that is only 0.9% of the country's income - among the lowest in the world - and total net debt of 41% - the lowest level in the last decade and among the lowest on record. Lowering the marginal tax rates for Canadians could have a multiplier effect on demand. A reduction in the marginal tax rates will free disposable income for consumers to spend on goods and services made by Canadian businesses, which can offset the impact of higher interest rates. These businesses will in-turn hire Canadians. Businesses themselves have been under-investing in capital equipment and technology. A lowered corporate tax rate will encourage more companies to deploy capital towards meaningful projects. While the government has moved to incentivize investment through an increase in the capital cost allowance rate, the depth and breath of the incentive is not enough to compete globally.

Getting Back Foreign Investment

Canada has been contributing heavily to Silicon Valley, handing over talent such as Elon Musk, and handing over companies such as Instacart. Why! It goes without saying that economic diversity outside of oil is a viable strategy. Foreign direct investment coming into Canada has declined by 75% since 2007 according to the Frazer Institute, owing to a confluence of factors that include a less attractive oil sector, a less competitive tax structure, and a less competitive regulatory environment. At this point nothing can be done about oil prices. Canadian oil assets require oil prices above C$65 per barrel for an investor to earn a suitable return on investment, as such the trend of energy companies leaving is difficult to stop. This is less so in the pipeline industry, but even they are pulling the plug on investments as the hurdles in getting environmental approvals are not worth mounting. For the first time in decades, the corporate tax rate in the USA is lower than that in Canada, which is a monumental change in regime. Until the tax rate or other incentives are introduced the investment return calculation will favour the US.

Shifting the Scale

The federal government should come up with strategies to address the areas where there is a Gap between Canada and other western countries. One of the levers the government can pull is obviously lowering corporate taxes, but there are other strategies such as reducing regulation, fostering more competition, and addressing the aging population. The cost of doing business in Canada is high in partly due to the lack of competition in many services that most businesses require such as in telecommunication, and insurance. On top of the lack of the competition the regulatory hurdles inadvertently offer strong protection to some these monopolies, which has to be addressed comprehensively for us to attract capital. The immigration policies while good is still not addressing the aging population issue, which has been stymying the level of innovation and entrepreneurship in the country.

FASTer Infrastructure Spending

The government has earmarked close C$186.7Bn to spend on infrastructure from 2017, but the programme has been slow get out of the blocks, resulting in a delayed impact on income and on the productive capacity of the country. This program is critical to reinvigorate aging roadways and bridges, expand public transit, and widen access to social housing. Of C$186.7Bn available there are reports that suggest that less than C$20Bn will be spent in the next 5 years. Furthermore, with elections around the corner the country runs the risk of these funds being used as a political tool to secure political leverage, as opposed to addressing real infrastructure needs. In budget 2019, greater accountability is needed and whatever can be done to accelerate project implementation should be considered. In the event of an economic slowdown a highly responsive stimulus package would be a necessity.

With elections just around the corner, there is a real possibility that the 2019 budget will be an election budget, geared towards handing out gifts in exchange for political support. However, Canada has real issues that needs to be addressed, issues that will impact the ability of the country to complete in an increasing globalized world. The Trump administration has reduced the relative attractiveness of Canada versus the USA as place to deploy capital. In addition, the USMCA trade deal clear tilts trade in favour the US. It is therefore critical now more than ever that the Trudeau led government takes into account Canadian competitiveness.

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