Who Do You Trust? The Broten Report and the Sad State of Provincial Finances

This week, the Province released the Nova Scotia Tax and Regulatory Review report, produced by Laurel Broten following a consultation process of several months. While the consultation was not on the scale of Graham Steele’s “Back to Balance” tour in 2009/10, it did involve a number of meetings around the province and input from a stated 250 individuals or groups. The report makes a long list of recommendations for change in Nova Scotia’s taxation structure, its regulatory framework, and in how government operates.

Unlike virtually any other government-sponsored report I can recall in recent memory, it landed with a dull thud for both the public at large and, it seemed, the government itself. Nobody embraced it except for a handful of business groups like the CFIB and the Halifax Chamber of Commerce. Not only did the opposition parties and their partisan supporters immediately start screaming about its recommendations, but so did many members of the public in reaction to the early media reports that it recommended taxing things like books, diapers, and electricity, reducing taxes on corporations and upper-income earners, and eliminating many of the special-interest exemptions currently built into the tax code.

For a report that the government commissioned themselves, the apparent lack of enthusiasm from that corner seemed rather curious. The immediate reaction in the media probably explains a good part of why they are keeping their distance from it. The news outlets did not find it hard to find people to appear on the news saying they hated the idea of taxing diapers and electricity, or putting up the price of gasoline. It is possible, I suppose, that such a deadpan reaction by government may be a communications strategy to not telegraph their punch, should they actually be planning to implement many of these recommendations. After all, it was probably a longshot for the opposition parties to expect that the Premier would stand up in Question Period and say that he supported higher taxes on families with small children. Only time will tell what changes may be in store.

Setting aside the frothy demands of those whose interests are threatened by these recommendations, do they actually make any sense? It is a very lengthy and complex set of recommendations, so my immediate reaction is somewhat mixed. The sense I get is that there is a lot of material here that absolutely should be taken seriously. But there is also a lot of space devoted to things that I just have to wonder why Ms. Broten even bothered about. Let’s take a quick look at both.

The report is positioned as a follow-up to the Ivany report. Its objective is stated as making recommendations related to changes in taxes and regulations to “sustain economic growth and stabilize the public finances” of Nova Scotia. It borrows from the “now or never” language found in the Ivany report by stating “Never is not an option”, and equates governments running continual operating deficits to individuals buying groceries on credit because they have no money to pay for them. The report makes the very correct point that with our population aging, and our labour force not growing, we will not be able to depend on income taxes to fund government programs to the extent we have done in the past. So it should not be surprising that the report looks to consumption taxes as the way to compensate for this going forward.

Just like the Ivany report, it sounds the alarm bells to justify what it is proposing. To quote: “Nova Scotians have to be willing to embrace the fact, or at least accept, that tough action is required today to achieve financial stability and economic opportunity tomorrow.” That tough action includes big changes to the income tax system, to streamline and simplify it; removing many of the existing HST exemptions (even though, as was pointed out Wednesday by the Premier, as provincial law currently stands, some of these changes would require a referendum – something that is just about guaranteed never to happen); introduction of a carbon tax similar to what exists in British Columbia; elimination and rationalization of most government regulations; a rather vague series of recommendations to make government more efficient and responsive; and a freeze on government spending for at least 5 years.

There is so much in the report that one can only touch on a few of the highlights. The goal of simplifying the income tax system is one that anybody who has ever filed a tax return can probably appreciate. There is a reason why tax accountants and tax-code lawyers do so well, after all. Broten cites an estimate that the cost of compliance with income tax systems across the country equates to 2% of GDP, which is absolutely stunning if true. As the report states:

“Simplifying the tax structure was a goal, or principle, of virtually every tax reform effort undertaken anywhere in recent decades, and this review is no exception. One of the primary reasons for the complication of the tax system can be found in the way tax changes are made. Here in Nova Scotia – and Nova Scotia is not unique – changes are most frequently made to address a specific issue at a given point in time. The change could be for economic, political, compassionate, or any number of reasons. The change is made to a specific, identified tax, with insufficient regard for the whole tax “system.” Over time, new governments, new demands, new social needs, and expectations are met with new tax exemptions, increases, credits, and myriad other tweaks and revisions, each of which piles more complexity into the tax system.”

Aside from tax simplification, the report also takes on the objectives of finding ways to reduce income taxes, thereby reducing disincentives to work while encouraging risk-taking and entrepreneurship; moving to more of a consumption/polluter tax model of revenue generation; reducing the general corporate tax rate to make Nova Scotia more competitive, while increasing the small business tax rate to reduce disincentives to grow; recommending a freeze on total government spending; reducing the regulatory burden; repealing outdated and unnecessary regulations; and moving to a model of the full cost recovery of fees. Quite a mandate.

Perhaps the most eye-opening part of the report for the casual reader is the useful context it provides for the existing state of provincial finances. For those of us who have worked in government for a long time, this is not a surprise, but it delivers the bad news in a very effective manner. In short: Not Good. Some of the key points:

• Operating Deficit: $679 million (this is the excess of what we’ve spent over what we took in during the year)
• Total Spending: $10.7 billion
• Total Revenue: $10 billion (of this, $6.6 billion is generated in NS, the rest is federal transfer payments)
• Net Debt: $15 billion, or over $15,000 per person
• Debt Service : $886 million (paying just the interest on your line of credit, essentially)

On the subject of provincial debt, Broten writes, “Borrowing to build for the future – investing in assets such as roads and bridges, transit infrastructure, and state of the art hospitals and schools – is entirely acceptable. Borrowing to fund programs or interest on past debt must be questioned, managed, and eventually eliminated.”

It’s certainly hard to argue with that. From a big-picture standpoint, it is unconscionable for governments to continue to spend borrowed money and kick the repayment can down the road for future generations to handle. Looking at the numbers, I can almost picture my late father trying to balance the family budget and pay the bills, looking at his bank accounts before uttering his favorite expletive, “Cripes!!”.

This again attempts to reiterate many of the same dire warnings about the state of provincial finances we have heard over the last several years. While those whose interests are threatened can argue against the types of changes included in this report and elsewhere, one must wonder what the alternatives are. The report really sets the stage for the need for Nova Scotians to pay more in taxes and fees, perhaps significantly more, while expecting potentially much less from government in terms of services. We probably will not like that very much. But what are the alternatives? If we continue as we have been, at some point we will not be able to borrow money at rates we can afford. And the prospects of ever being able to repay that debt are dim at best. Short of a federal bail-out and becoming a ward of the Government of Canada, I am at a loss to offer any other alternatives.

To illustrate the challenges associated with government spending, the report provides some context:

“Government program spending has increased at more than twice the pace of inflation over the past 30 years. As set out above, 2013–14 provincial spending was $10.7 billion. By contrast, in 1984, the budget of the province was $2.8 billion. Had spending kept pace with inflation, last year’s total would have been approximately $5 billion rather than double that amount.

This is not to suggest that government spending should track inflation. There are a multitude of other factors involved. The cost of programs, particularly health-care services, has escalated at a rate far in excess of inflation, and Nova Scotians should expect to benefit from health-care advances to the same degree as all Canadians. Health care has steadily increased its share of total program spending, from 25 per cent in the early-to-mid 1980s, to 30 per cent a decade later. By 2000, health care had become about one-third of provincial spending, and today for every dollar the province spends, more than 40 cents go to health.

Obviously, health care is the biggest expense. Others include education (13%); community services (10%); interest on debt (8+%); labour and advanced education, which includes payments to universities and colleges (7%); and transportation and infrastructure (4%). This leaves 18 cents on the dollar for everything else: the justice system and police, natural resources, pension contributions, the environment, business and industry programs, etc.

By category, 37 per cent of total government spending pays salaries and benefits of public servants, including departmental staff, doctors, nurses, teachers, and many others. Grants to municipalities and support for individuals on income assistance, in long-term care, and with other needs take 33 per cent; goods and services required for government operations consume 15 per cent of the budget; professional fees, 3 per cent; and finally, interest on debt, at 8 per cent, rounds out spending.”

The report also makes some interesting points on the sources and uses of funds by the province. It notes that personal income tax represents about 25% of NS revenue, compared to 18% in 1983/84, while corporate income tax makes up about 4% of provincial revenues. Add to that the note in the report regarding Nova Scotia’s income tax rates which are among the highest in the nation, the aging population, and the shrinking labour force, and it is not hard to reach the conclusion that the personal income tax well is running dry. This helps explain in part why the report puts such emphasis on consumption taxes going forward.

As part of the tax simplification argument, the report recommends eliminating many of the existing exemptions from the HST such as printed books, children’s clothing, shoes, and diapers; feminine hygiene products; residential energy; and first-time home purchases. It proposes offsetting these in part by changes to income taxes, presumably targeting those changes to people most in need of help. Naturally the opposition parties have instantly jumped on this as a reason to dismiss the entire report.

The report also recommends other changes to the income tax rules, such as increasing the personal exemption amount, eliminating bracket creep, getting rid of the Volunteer Tax Credit and the Healthy Living Tax Credit, and combining the top two income tax brackets into one. This latter recommendation was also jumped on by critics as giving a tax break to the most wealthy, which it would. Aside from whatever it saves in simplification and whatever it provides in incentives for the wealthiest people to continue to want to live here, I find this one hard to understand. My late former boss at Finance, Gillian Wood, used to tell me that since so many Nova Scotians pay little or nothing in the way of income taxes, promising reductions in that area were pretty much worthless politically. So moving to a model with higher consumption taxes with offsets in income taxes may not have the desired effect.

The report also recommends changes to corporate income tax rates to bring them more in line with others across Canada, and paying for this in part by increasing the small business tax rate from 3% to 8%. Again, the recommendation was jumped on by critics, and in fairness, there seems little rationale found in the report to demonstrate that the small business rate is too low. And like some of the other recommendations, the optics are terrible.

The idea of what the report calls a pollution tax, basically a variation of B.C.’s carbon tax, is intriguing. I have long felt that we need to do something along these lines. Thanks to politicians and the news media, the population is hyper-sensitized to gas, oil, and electricity prices, but we are working at cross-purposes. We complain about the price of gas, but look at the number of supersized pickup trucks that are never used for work that one sees in suburban mall parking lots. We scream about heating oil and electricity prices, but we build outsized new homes that need all that space to be heated, cooled, and illuminated, and filled with electronics to entertain us. We want it both ways, and that just isn’t possible. Again, critics pander to the sensitivity of the citizenry to pan this recommendation, but I think we need it.

Having said all that, along with a number of other changes to the way we levy taxes in Nova Scotia, we come to the most curious part of the report. What does it all add up to? The answer, seemingly, is not much. The report includes a summary table, reproduced below (click to enlarge):

broten

Now, perhaps I’m dense, but why would you do all these politically suicidal and wildly unpopular things for what amounts to zero net gain? The two biggest line items are the first, Freeze Expenditures, which although desirable from a fiscal standpoint seems highly problematic in practical terms; and the last, Priority Transformational Investments/Tax Relief/Debt Reduction, which the report really does not discuss as near as I can tell, and which we do not have any insight into. If it is primarily Debt Reduction, then we have gained something. When I see the phrase “transformational investments” though, I worry that it is just more money frittered away.

There is a large part of the report that discusses things that seem oddly out of place in a report that initially focused on tax reform. The second half of the report talks about Nova Scotia’s regulatory environment, with yet another section relating to government fees. Both of these are interesting to some, no doubt, but strike me as somewhat jarring to find in a report discussing tax policy, and at the same time highly academic and rather naive. Having been involved in the “reinventing government” initiatives here in the 1990s, I can tell you that changing the way government works in a meaningful way is a daunting task. But that is another discussion for another time.

I have to give the government credit for commissioning this report, and kudos to Ms. Broten for putting into the public forum some discussion of the dire situation in which Nova Scotia finds itself. While the many of the recommendations are unpleasant, I think it would be a mistake to dismiss them out of hand. In many ways, it comes down to a question of who one trusts – those who try to get us to believe that the situation really is as bad as the report suggests, or those who are trying to convince us that they have a fundamentally different way to fix our problems. Until I see some evidence that there is another set of solutions, I can only believe that some combination of government spending significantly less while taxing us in a different way that leads to more government revenue is our only way out.

Not Good.

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