Chrystia Freeland finally gets serious with her second budget

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Paul Martin needed two budgets to become Paul Martin.

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The late Jim Flaherty’s fiscal update in November 2008 nearly triggered a constitutional crisis, before he got serious about the Great Recession and tabled a budget in January 2009 that earned him a place in Canada’s pantheon of economic stewards.

If there is a group in Canada more averse to risk than the business elite, it’s the political class, which proves over and over again that it’s incapable of making a difference before first making things worse. Martin, facing a debt crisis after Jean Chrétien made him finance minister in 1993, balked at making the truly hard decisions in his first budget. Flaherty, a foot soldier in former Ontario premier Mike Harris’s “Common Sense Revolution” in the 1990s, needed time to get over his ideological aversion to deficits.

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So, too, Chrystia Freeland, who, along with her boss, Prime Minister Justin Trudeau, appears to have needed a bloody war in Europe to appreciate the seriousness of the crisis at her door.

The delay is frustrating, but not unusual. Martin needed a dressing down by Canada’s creditors to appreciate that the mismatch between spending and revenue had grown too wide to be fixed by promises and half-measures. A decade-and-a-half later, Flaherty rediscovered the hard way that austerity doesn’t spur economic growth when all the private money has fled out of fear of a depression. The 2022 budget, arguably the closest the Trudeau Liberals have come to delivering a long-term growth plan, suggests Freeland received her wakeup call in recent months.

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Freeland’s tendency has been to equate firefighting with reconstruction. She and her cabinet colleagues like to tweet and retweet statistical evidence of how much faster Canada’s labour market recovered from the pandemic compared with that of the United States. However, the gravest challenge facing her as finance minister was never COVID-19, but fixing all the vulnerabilities the pandemic exposed.

Canada is an aging, complacent society that wears a dysfunctional health system as a badge of honour and invests more in housing, an unproductive asset, than in research and development, the core of innovation. The threat is that Canada gets left behind as the world shifts to a digital, carbon-neutral economy because politicians are too worried about “vote efficiency” to risk alienating their vote blocks, while executives cling to the notion that the hurdle rates they achieved selling goods and services to the U.S. during the rise of the baby boom will magically return.

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‘We are falling behind’

Few rich countries are worse at generating wealth than Canada. Easy access to the U.S. market disguised that reality for decades, as did the commodity boom that came with China’s rise from poverty in the 1990s and 2000s. That world is over. The crutches are gone. Canada has to learn to create wealth on its own. One of the most noteworthy things about Freeland’s budget was that she’s willing to say the words.

“We are falling behind when it comes to economic productivity,” Freeland said in a speech to the House of Commons after tabling her second budget as finance minister on April 7.

“Productivity matters because it is what guarantees the dream of every parent — that our children will be more prosperous than we are,” she continued. “This is a well-known Canadian problem and an insidious one. It is time for Canada to tackle it.”

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It was time for Canada to tackle productivity in April 2021, too, when Freeland tabled her first budget; a 725-page, 8.9-megabyte, everything-but-the-kitchen-sink plan that was so unfocused that even Mark Carney, the former central banker turned Liberal partisan, struggled to defend it.

(Productivity) is a well-known Canadian problem and an insidious one. It is time for Canada to tackle it

Chrystia Freeland

A lot has happened since then. Inflation, a non-story for the better part of three decades, is now all anyone can talk about. President Joe Biden helped get Michael Kovrig and Michael Spavor out of detention in China, but has done little to dull the protectionist impulses stoked by his predecessor, Donald Trump. Trudeau trigged the Emergencies Act to clear protesters and their vehicles from downtown Ottawa and important border crossings. And then on Feb. 24, Russia invaded Ukraine even as Western leaders implored him to resist, an act of defiance that shows the world’s autocrats will no longer be cowed by the democratic powers that won the Second World War.

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The 2022 budget had a maturity that Team Trudeau’s previous financial plans have lacked. The document is a relatively concise 304 pages and 4.3 megabytes in its digital form. Inflation and healthy corporate profits left the government with considerably more revenue than it had expected, but, unlike previous years, the cabinet resisted the urge to spend the windfall in its entirety.

Freeland set a course that would see the deficit nearly erased within five years, while the debt as a percentage of gross domestic product is forecast to drop to 41.5 per cent over that period, compared with 46.5 per cent currently. It’s not the sturdiest of fiscal anchors, but it should be enough for Canada to preserve its elite status with all the credit rating agencies, and it’s as good as anyone else is doing.

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Hurting ‘all Canadian citizens’

Executives and Trudeau’s cabinet have struggled to find common ground for years. “The fact that our government cannot seem to comprehend the effectiveness of the private sector is a real issue that will hurt all Canadian citizens in the long run,” Paul Desmarais III, chief executive of Sagard Holdings ULC, an alternative-asset manager owned by Power Corp. of Canada, said on LinkedIn in June 2021.

The corporate elite will dislike sections of the budget. Trudeau’s decision to follow through on his promise to voters (and New Democratic Party Leader Jagmeet Singh) to increase taxes on the profits of big banks and insurers will be poorly received at the Business Council of Canada. The government’s pledge to make it harder for the richest Canadians to avoid the alternative minimum tax could also add to the workload of the business council and other corporate lobbyists this summer.

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Tax collectors should probably avoid singling out specific industries, and Canada’s personal tax rates are already relatively high, which is a problem for companies engaged in a global fight for talent. At the same time, it’s become received wisdom that the political polarization that has made policy-making so difficult is the result of income inequality and a sense the game is rigged in favour of the world’s biggest companies and the men and women who run them. No one said the political stability that bosses such as Royal Bank of Canada chief executive Dave McKay say they desire would be free.

But there are lots of echoes in the budget of things that various business lobbies have been saying they wanted for the past few years. One of the more egregious — not to mention costly — measures in the tax code is the lower rate that smaller companies pay on their profits, which means they have an incentive to stay small. A neutral approach to taxation would treat all firms the same, a change the politically powerful Canadian Federation of Independent Business would never let happen.

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Freeland proposes to offset the distortionary effects of the policy by making the preferential rate available to companies with taxable capital of $50 million, compared with $15 million currently, a tax break that would cause the federal government to forego revenue of about $660 million through 2027.

The marquee item in the Trudeau government’s productivity plan is the Canada Growth Fund, which would eventually be seeded with $15 billion to invest alongside private capital in potentially game-changing companies and projects. The idea, essentially, is to create a publicly owned private-equity fund that would be run by professional asset managers who enjoy a level of independence equivalent to that of the governor of the Bank of Canada.

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It’s a bold play. The Canada Infrastructure Bank and the supercluster program were built on similar theoretical foundations. Neither has proved the theory works in the Canadian political context, at least so far.

However, that isn’t a reason to condemn the growth fund from the outset. Tax cuts might do the same thing without the bureaucracy. But, again, in the Canadian context, that’s theoretical. There is reason to be skeptical that Canadian industry, which is dominated by legacy oligopolies, can be inspired to do anything that would risk its profit margins or its ability to dole out dividends.

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Canada’s public pension funds rank among the world’s best. There should be a deep pool of investing talent from which to draw, and the Bank of Canada’s history shows that a public entity can operate effectively as long as it has a clear mandate and strong governance.

To be sure, the Trudeau government has a well-earned reputation for micro-managing and political engineering. Freeland’s productivity plan has merit. She said the details about the growth fund will come in her autumn fiscal update. That’s when we’ll know for certain that she and her colleagues have woken up.

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