The Federal Budget: Q and A with Professor Gilles Duranton

Finance Minister Jim Flaherty will introduce a federal budget Thursday that is anticipated to be one of the most frugal with billions of dollars in cuts to programs and services. Many Canadians are anxious about where their wallets may feel the pinch as a result. Writer Anjum Nayyar spoke with Professor Gilles Duranton in the department of economics about the potential outcome of the upcoming budget.

This budget is being forecast by some as the most frugal, tight-fisted economic strategy since 1995, when Paul Martin took an axe to federal spending to reduce Ottawa’s budget deficit. What do you think will be the 3 of the biggest areas hit with cuts in this March 29th budget?

It may not be as bad as they tried to get us thinking. There will be several surprises, despite them leaking things in the pre-budget period. There have been things talked about including the old age security and postponing pension rights to 67. That is definitely in the cards and that was bound to be in the cards in the future in any case. That is going to be done in a gradual way. They will try to reduce what they give back to the provinces so they’ll likely redistribute less to provinces in this budget. There will also be cost cutting inside all the ministries, possibly a 10-per-cent cut in the functioning budget. Given recent expansions there is scope for cuts here.

Flaherty has mentioned in the past that one of the major themes in the budget is going to be innovation, research and development (by business) and narrowing the productivity gap. The government is also expected to alter key tax breaks to provide more help for small high-tech companies and software start-ups. What are your thoughts on providing incentives for this area of growth?

I think the diagnostic here is right in the sense that Canada’s productivity is somewhat lagging, particularly in the bigger provinces such as Ontario and Quebec. That being said, it’s not easy to boost productivity. I used to live in England in the early days of New Labour and  Gordon Brown was all about boosting productivity but in the end he was not able to do anything.

The easiest thing to do for a government is to give tax breaks for research and development. The problem with that is if you do it across the board, that’s a very expensive tool to use because companies already do a lot with R and D. So what you want to do is to try and induce them to do more and avoid giving them tax breaks on what they already do. Otherwise, if you give them big tax breaks to something they already do, you’re just giving money to companies and it’s not very efficient. So what they are trying to do is find some niches where tax breaks will not cost so much and induce firms to do much more. In practice, this may be true with small firms and small start-ups. The record for this type of intervention is not that great, however.

The tax breaks will probably not induce the best firms to do that much more in research and development. They already do a lot. Instead this will induce those firms at the margin to do more search and development. So it may not be such a bad thing, but boosting research for marginal firms that are hesitant to do research is unlikely to be something that takes our productivity to US levels.

How much of this new budget do you think will push fiscal responsibilities back on to the provinces? What kind of a position are provinces in at this point to take that on?

They’re going to try and do something by reducing what they give back to provinces. At the same time they’ll be constrained by two things. The first is they have made promises before the last federal elections that they weren’t going to touch funding to provinces very much, so there’s only so far they can go. What they can play on is that some provinces are doing ok, some are doing poorly.  The former like Alberta may agree to some cuts. Then, Ontario will be in big trouble. Reducing transfers to lower levels of government is the way higher levels of government in Canada balance their books. In the mid-90s the federal government delegated lot of expenditures to the provinces and that was followed by the provinces delegating expenditures to the cities. So that is what may happen again. 

There have been suggestions to make cuts to Old Age Security. Who are the winners and losers in this?

If we go back in time, the situation with older citizens was not very nice with a large fraction of them in poverty. After that there was a huge catch-up and today the situation is much better, although things could always be better. What they don’t want to do is to cut the monthly allowance, but they do want to make eligibility more stringent by raising the bar to 67. They will do this over the next two-to-five years. People turning 60 now will have to wait until 67 to receive OAS. More means testing on a number of services to pensioners may also be introduced.

This budget is being positioned as largely being about cuts and deficit reduction.  Are there areas where you think the government will be making new investments?

Here they’re not trying to raise expectations, but rather quite the opposite. But there will be some investments for research. Once you lower expectations, you can give back to make the budget more optimistic. The budget surprise will probably be in this direction. Maybe some direct funding for research and higher education. Maybe something else. We'll see.