Prime Minister Justin Trudeau's father once famously compared living next to the U.S. to sleeping with an elephant -- a twitch or a grunt south of the border can have big consequences for Canada.
Well, President Trump's proposed tax plan is considerably more than a twitch. Trump is proposing significant cuts to both business and personal tax rates, which would reduce Canada's competiveness in attracting investment, skilled workers and entrepreneurs -- all of which contribute to a dynamic and growing economy.
The Trudeau government should take action. But with an expected $28.5 billion budget deficit and red ink as far as the eye can see, what can be done in a fiscally responsible manner?
U.S. President Donald Trump and Canadian Prime Minister Justin Trudeau walk from the Oval Office to the Residence of the White House in Washington, U.S. Feb. 13, 2017. (Photo: Kevin Lamarque/Reuters)
The answer lies in the Liberal Party of Canada's own past, specifically the Chrétien era of the mid-1990s and early 2000s.
When Jean Chrétien became prime minister in the early '90s, Canada was in a much worse competitive position than today. It had been more than two decades since the last balanced federal budget. The resulting debt accumulation created a great deal of uncertainty, hobbling investment. Nominal federal debt increased from $20.3 billion in 1970/71 to $527.9 billion in 1993/94.
At the same time, relatively high personal tax rates encouraged many of Canada's best and brightest to move elsewhere -- a phenomenon often referred to as Canada's brain drain. In response, the Chrétien Liberals implemented a series of critical spending and tax reforms.
First, starting in 1995 they reduced federal program spending by nearly 10 per cent over two years. This, along with crucial program reforms, helped the federal government eliminate the deficit for the first time in a generation.
A virtuous cycle ensued including a string of budget surpluses that allowed Ottawa to chip away at its mountain of debt, with debt falling by $30.5 billion over Chrétien's tenure. Paying down debt meant lower interest payments on the debt, freeing up resources for major reductions to personal and business tax rates.
In short, the Chrétien Liberals pursued historic reforms that made Canada more attractive for investment. The underlying focus was more prudent spending, balanced budgets, debt reduction and competitive tax rates, which, along with similar reforms at the provincial level, paved the way for a decade of prosperity, with Canada outperforming other industrial countries on economic growth, job-creation and business investment.
Prime Minister Justin Trudeau speaks with former prime minister Jean Chretien following the Speech from the Throne in Ottawa, Canada on Dec. 4, 2015. (Photo: Geoff Robins/AFP/Getty Images)
Simply put, the lessons from the Chrétien Liberals can be applied today, particularly in response to Trump's tax plan. Prudent spending, debt reduction and tax rate cuts would make Canada a more competitive location for investment and skilled labour, and help foster the prosperity Canadians enjoyed following the Chrétien reforms.
This, however, would mean a dramatic change in course for today's Trudeau Liberals. In contrast to the Chrétien era, this government has moved away from proven policies and instead embraced significant deficit spending and debt accumulation. Indeed, the Department of Finance's own projections suggest decades of persistent deficits and debt accumulation are imminent.
Prime Minister Trudeau has also acted contrary to his Liberal predecessor by raising tax rates on skilled workers and entrepreneurs. Combined with provincial tax rates, Canada's top personal income tax rate is now 53.5 per cent for someone living in Ontario, while the federal-state top tax rate in the U.S. is 46.3 per cent. This raises the spectre of a new brain drain to the U.S., particularly given Trump's plan to reduce the U.S. top tax rate by 4.6 percentage points.
Finally, Trump's plan (if implemented) will also make Canada less competitive on business taxes. His proposal reduces the average federal-state corporate income tax rate from 39 per cent to 21 per cent, lower than the 26.5 per cent federal-provincial combined rate in Ontario.
While it may run against the grain for the Trudeau Liberals, the Chrétien reforms provide a road map on how to make Canada's economy more competitive in a Trump era.
This piece was co-written by Hugh MacIntyre, Fraser Institute analyst.
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