February 7, 2012 - MLI's recently released study, Canada's Looming Fiscal Squeeze: Collected Essays on Solutions, is highlighed in a Financial Post exclusive published today! The FP summarizes the key ideas from the collected essays on how to solve Canada's looming demographic deficit. Authors are Bev Dahlby (U of Alberta), Janice MacKinnon (U of Saskatchewan and former NDP finance minister, SK), Ron Kneebone (U of Calgary), William Watson (McGill University), and MLI's Director of Research Jason Clemens.


Financial Post: Demographic Deficit

Five ideas to raise the money we'll need to deal with health care for a rapidly aging population

February 7, 2012

The current debate over changes to Old Age Security (OAS) highlights a much larger aging population problem that Canada, like every industrial country will face over the next two decades. In 2011, the Macdonald-Laurier Institute commissioned a study by McGill economics professor Christopher Ragan to estimate the size of the coming demographic deficit. This aging-related shortfall in government revenues compared with spending comes of two reinforcing effects:  slower revenue growth and higher spending due to health-care and retirement income programs. Prof. Ragan calculated that the demographic deficit would reach 4.2% of GDP, or roughly $67-billion in today's dollars. How to deal with this deficit? The Macdonald-Laurier Institute solicited competing solutions, summaries of which appear below.

Explore co-insurance revamp EI programs

The IMF describes the fiscal adjustments of the mid-1990s as exemplary policies. Two key features stand out. First, the public was behind the need for a period of fiscal austerity to eliminate deficits and reduce debt. Second, the first priority in the fiscal adjustment was reviews of public expenditure programs at all levels of government to ensure effectiveness.

Health-care spending is the largest public expenditure program, and there will be upward pressure on health-care spending because of population aging. Improving the efficiency of health-care spending should be the highest priority of government. Reforms include use of information technologies, programs to improve preventative care, and more emphasis on provision of chronic care services in special institutions and patients' homes rather than the hospital system. Reforms should be made to the payment of doctors and hospital services, as well as pharmaceuticals.

Co-insurance arrangements could be administered through the income tax system, whereby medical and hospital services are treated as a taxable benefit with annual limits on payments based on an individual's income.

Maintaining labour force participation rates and promoting productivity improvements is also key. Reforms to Employment Insurance (EI) programs will have to be made. Using experience rating to determine employer contributions to the EI fund would provide an incentive for employers to avoid layoffs and would allocate more of the cost of the EI program to those industries and firms that make frequent demands on the system by laying off employees.

The fiscal adjustment should be made through expenditure restraint, but some tax rate increases may be necessary. If so, increases should be restricted to sales taxes and real property taxes, which impose much lower costs on society than income taxes. — Bev Dahlby, University of Alberta

Deliver more services through private clinics

A multi-faceted approach to debt reduction is required since neither spending cuts nor tax increases alone can address challenges like closing the fiscal gap that will emerge as the Baby Boomers age.

On the spending side, difficult questions need to be asked about departments like Aboriginal Affairs. For example, are the best interests of First Nations being served by continuing to invest in infrastructure on reserves that have no viable economic base? Instead, should that funding be redirected to invest in the education and training of First Nations, with the requisite social programs to facilitate the transition?

The demographic problem cannot be addressed without fundamentally changing our health-care system and its funding. More services should be delivered by private clinics instead of the traditional hospital model. Such clinics have reduced both wait times and costs in Saskatchewan and other provinces. Patients should be diverted from emergency rooms and other costly medical facilities to primary health clinics staffed by salaried teams of health-care professionals. Public private partnerships should be used to build more long-term care facilities where elderly patients can be housed in less expensive facilities more geared to their needs.

The federal government's announcement that after 2016-2017 transfers to the provinces for health care will be reduced from 6% to track growth in the economy (with a floor of 3%) should encourage provinces to work together to reduce costs. Salary and benefit increases for health-care professionals have taken a significant share of new provincial spending on health care. Instead of competing, provinces could reduce costs by co-operating to limit salary increases.

Finally, 25% of the costs of health care should come from making health care a taxable benefit. Such a policy would be fair since what one pays would be related directly to income, caps can be established, and provisions can be made for those who have special medical problems.
— Janice MacKinnon, former NDP minister of finance, Saskatchewan

Cut out unneeded tax credits, programs

Economists have an unvarying view of taxes: Rates should be low, bases should be broad and, beyond that, where taxpayers have a choice of how to declare their income, the system should not push them in one direction or another. More revenue can be raised though, without increasing tax rates. There are numerous tax expenditures that have been granted to some or all taxpayers for various reasons of fairness, consistency, or aggressive lobbying. On the personal tax side there are more than 100 such carve-outs. For instance:

— $150-million for personal public transit tax credits. How many taxpayers pocket a tax credit for choosing transportation they would have chosen anyway?

— $115-million for first-time homebuyers. Recent history has shown the perils of excessive investment in housing.

— $2.3-billion age credit. The Baby-Boom generation that is about to take advantage of it has largely caused the problem of a rising structural deficit.

— $115-million for the Child's Fitness Tax Credit. Does it encourage new fitness activities or merely reward activities already undertaken?

There are fewer tax expenditures on the corporate side, "only" five dozen or so, but they raise similar questions:

— $3.7-billion for the Scientific Research and Experimental Development Investment Tax Credit, which develops profitable economic activity. Why should this form of profit seeking be privileged over others?

— Why is there an Atlantic Canada Investment Tax Credit ($273-million) tilting investors in the direction of a particular region?

— $3.6-billion for the lower tax rate offered to small businesses. Why should the state favour a particular size or form of business?

I don't have a precise dollar value for how much we could save by eliminating or reducing some of the 170 different tax expenditures available at the federal level alone. But it should run into the billions, possibly even the tens of billions, of dollars. — William Watson, McGill University

Cap debt-to-GDP ratio at 60%

A simple, transparent rule that would enable governments to retain flexibility and at the same time be guided along a path toward long-term fiscal rectitude is a target for the debt-to-GDP ratio. I propose a cap of 60% on the debt-to-GDP ratio and that this be achieved by requiring annual deficits to be limited to no more than 1% of GDP.

Once we fully recover from the recession, most governments in Canada will be at or near budget balance. By roughly 2016, the debt ratio for all governments in aggregate will be about 40%. As the fiscal squeeze begins, it will at first simply halt a fall in debt ratios but then they will start to grow.

According to Ragan, by 2021 spending will exceed revenue by about 1% of GDP and the debt ratio will be about 43%. If through a combination of slowly rising tax rates and gradual moderation of spending growth the deficit remained at 1% of GDP per year, then by 2040 the debt ratio would top out at about 60%.

Responding to the fiscal squeeze does not require jarring stops or wrenching adjustments.

To avoid those outcomes, it's crucial that we implement this plan right away and in so doing force voters and elected representatives to begin confronting the unfortunate fiscal facts implied by the coming fiscal squeeze. — Ronald Kneebone, University of Calgary

Fast track immigrants' professional credentials

Canada should pursue changes in the immigration system that better ensure workers coming to Canada have their credentials recognized, that facilitates a process for private companies to more easily bring in needed foreign workers, and that increases the percentage of work-related immigration rather than immigration based on family reunification. Increasing the likelihood of productive and working immigration can contribute to a broad solution.

One measure that would mitigate spending while encouraging more seniors to remain in the labour force longer is increasing the age of eligibility for public retirement programs. There is a direct link between the projected deficit and the increase in life expectancy. Life expectancy for males born in 1966 when the Canada Pension Plan was introduced was 69, providing four years of benefits.

Life expectancy is now roughly 79, which represents a marked increase in the cost of benefits. If the age of eligibility were indexed from the beginning, it would be 74 for males today. A slow approach to increasing the age of eligibility to 70 could be made, perhaps by three months per year over the next two decades, while imposing no changes for those in retirement or close to it.

One cannot reasonably evaluate the solutions available for the coming fiscal gap without also discussing taxation. The Canadian tax system has become more complicated over the past decade. The cost of personal income tax expenditures has increased by 85% since 2001. Myriad new tax credits have been introduced, reducing revenues often without improving economic incentives.

A better approach to taxation, and one that could increase rates of economic growth by improving incentives for work effort, investment, and entrepreneurship, is to eliminate many of these tax credits in favour  of a lower marginal tax rate. — Jason Clemens, Macdonald-Laurier Institute

— The full essays from which the summaries above have been drawn are available at www.macdonaldlaurier.ca



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