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Monday 6 July 2015


Guest Post written by JM
Oil has done many great things for Newfoundland and Labrador.  It has diversified our economy, generated wealth, provided tremendous opportunities for our young people, and given us a glimpse into a truly global industry.  Oil has fundamentally changed this province, the people, and our culture.  We can attribute to it a collective confidence on a level never conceived in the pre-oil Newfoundland and Labrador.  
But it can be argued that it has also incubated an undertone of both arrogance and invincibility, a condition which has particularly plagued our political leadership.  It has led to us to think, dream, and spend as if we had made the economic big leagues. From the mammoth Muskrat Falls public works project to the 35% increase in government spending, not once did we consider our exposure should oil prices return to their historical (and far lower) valuations. 

History has repeated. The oil price collapse has demonstrated just how weak our economy really is. 
As we move into a Fall election, voters should seek a strong fiscally conservative government; one willing to correct the fiscal imbalance which exists in the province.  The problem needs to be corrected now in order to ensure that when the second “oil boom” occurs in this province (2025-2035) we will have the ability to make long term investments from the excess oil royalties; we should plan not to be left with even higher debt, debt service costs and salary obligations to a bloated public service than the government created during the past few years. 
Within the next two posts, on Uncle Gnarley Blog, I will focus on the issue of short to medium term budget planning. 
I suggest it is vitally important, over the next five years, that we encourage our government to get back to basics in day to day business of providing strong management to government. 
We must correct the fiscal imbalance and get back to balanced long term budgeting.  Only by implementing tough measures now, will we be able to truly benefit from the second anticipated royalty boom in the province and, in the process, provide much needed long term sustainability. 
This 5 year plan will involve ideas for both raising revenues and cutting taxes.  But the plan must be gradual.  For that reason, the remainder of this post will consider the first step in reducing the fiscal imbalance: raising new revenue.
Increasing Revenue – A Modest Proposal
By nature I am a fiscal conservative.  I believe that raising taxes hurts the economy.  However, history in this country, and in the province, clearly documents that premature tax cuts are more dangerous to our long term economic stability than raising taxes. 
The tax cuts of the 2006-2010 period were premature.  Although Dwight Ball is correct when he states an HST increase is a “job killer”, I believe the changes implemented in the 2015 budget were necessary.  Fundamentally, the current government has only corrected their previous mistake of lowering the HST and cutting income taxes, in the first place. 
As identified in PART II, due to our heavy reliance on oil royalties, the small changes in taxation in the 2015 budget will have a minor impact on revenue growth.  The small increases implemented in 2015 will only serve to stabilize revenue in the face of a weakening economy. 
The author will like to suggest some other modest, but important actions, the government can take to increase revenue:

1.          Implement a tax on junk food
The spiraling cost of health care is unsustainable. The problem is due, in part, to the relatively poor health of Newfoundlanders and Labradorians, as documented in a recent report identifying 30% of residents as obese.  The problem is due in no small part to the lack of affordable fresh foods, and a culture that promotes unhealthy eating. 

By taxing junk food and fast food you are rightly penalizing the industries which contribute to an unhealthy culture.  By taxing junk food you are following the government’s practice of taxing ‘vices’ such as tobacco, and alcohol.  Hence, it is very reasonable to consider a tax on ‘junk food’, which includes fast food.  A sample calculation on how much revenue the measure would generate is provided below:
Consumers                         400,000
$/week                                $10 per week
Suggested Tax                   15% (Double the provincial portion of the HST)
Revenue                               $30 Million annually

The increase may seem high, but this is a token tax!  I suggest the revenue should be used to promote healthy eating habits, and to subsidize local agriculture. 
In addition, I suggest one of the greatest legacies of Muskrat Falls (possibly the only one) might be that ‘surplus’ power is used to power large greenhouses on the West Coast of the island. 
But do not sigh if you are thinking a comparison with Sprung!
Greenhouses, located on the West Coast, would have a longer natural growing season.  The initiative would lead to rural diversification.  It would stabilize the security of our food supply.  Greenhouses which grow tomatoes, peppers, greens, and other produce would serve to lower costs, and provide more nutrition to citizens of the province.
This is not 1988; the province is now better ready for the development of a large greenhouse complex.  The real financial benefit:  eventual savings in health care.  The larger issue of health care is beyond the scope of is paper, but there is considerable literature which establishes the link between healthier living and lower health care costs. 
The eating habits of Newfoundlanders and Labradorians are some of the worst in the world.  The problem very directly relates to our record of relatively high spending on health care services.  I suggest it is time to tax the culprits who produce these products and encourage local, healthy and sustainable nutrition. 

2.          Corporate Income Tax

The Provincial Government should prepare and release benchmarking which compares corporate tax rates in NL (combined with the federal tax) with other provinces in Canada, and against other jurisdictions in the world.  For reference, NL has the 4th highest corporate tax rate in Canada.  Accordingly, we should not forget that our corporate tax rate should remain competitive, internationally.  Due to the federal reductions offered by the Government of Canada, there may be an opportunity to increase provincial rates.  We need to, at least, be at the OECD average and better than the rates applied in other oil centers.  As shown in Figure 1, there may be an opportunity to increase corporate income tax by 1-2% and remain competitive.   As with income tax, the provincial government may be able to take the recent reductions offered by the federal government. 

For various reasons, the idea of raising corporate income tax is not one to which I subscribe.  But the necessity to increase revenue is influencing this recommendation.   Presently, corporate taxes provide about $400 million annually to the province.  I recommend targeting a 10% increase.  The measure has the potential to yield $40 million per year in new revenue.

Corporate Income Tax                         $40 Million per year

1.          Targeted Returns From Nalcor:
Within the 2015 Budget Highlights document  the government alluded to the large revenues which Nalcor will generate.  They failed to mention two very relevant facts regarding how this revenue stream is produced: (i) the province has been borrowing equity to provide Nalcor the “complete payback” it promises by 2025 (the amount excludes the interest paid by the province) and (ii) any such revenue is largely coming from the pockets of Newfoundlanders; essentially it is a tax on electricity rates. 

The reader might wish to consider that the annual interest payment, alone, on the Muskrat Falls project will be about $320 million (composed of interest on the $5 billion Federal Loan Guarantee and interest on $3.2 billion borrowed provincial equity).  If all the energy were sold on the open market, assigning no fee for transmission, the sale will yield only about $225 million (4500 GWhr at 50$/MWH).  Any revenues coming from Muskrat Falls, therefore, are from our very own pockets. 

A more balanced view of the revenue stream from Muskrat Falls can be found in the following reference in an article posted on The Sir Robert Bond Papers Blog entitled "Muskrat Falls: delayed dividends, more equitry needed.

That said, I suggest the province should mandate Nalcor to provide dividends to the province in an amount sufficient, at least, to pay the interest on the equity the province is borrowing to pay for these projects.  The amount would be in the range of $120 million per year. 

In the period of 2016-2020 an anticipated $120 million dollar dividend from Nalcor is a high expectation anyway.  Nalcor might achieve this target but only if it cuts costs, and reduces employees, and employee benefits, like every other energy business in the world.  Therefore, we might ask: why has Nalcor CEO Ed Martin not implemented those market intervention strategies already?

                Nalcor Targeted Revenue             $120 million per year (the figure is higher post 2020)

2.          Hibernia Holding Corporation
Most readers are aware that the Hibernia Holding Corporation (HHC) is a federal holding company which owns the 8.5% federal stake in Hibernia.  The company is listed in Calgary, not Newfoundland and Labrador. It is a very profitable investment for the federal government. 
The province has tried many times to get the federal government to transfer this 8.5% ownership.  The federal government has retorted with the entirely reasonable position that the stake should only be sold at fair market value.  (As an aside, I would like to know if this Alberta registered holding company pays provincial corporate tax to the NL government.) 

Although not a direct source of revenue, I suggest the province of NL should argue given that the federal government has already made their investment back on the Hibernia development, the revenues from the HHC should now be re-invested in deepwater exploration in Canada.  Federal government revenues from the HHC should be reinvested in a Petroleum Incentives Program or “PIP” grant type of program for Canadian deepwater exploration (all Provinces).  This approach would certainly be a more palatable position to the rest of Canada. 

Uncle Gnarley might be mortified at the thought Nova Scotia might benefit from Hibernia revenues.  Likely, he remembers how Nova Scotia betrayed Newfoundland during negotiations for the original 1985 Atlantic Accord.  However, I am hoping the industry has matured.  Newfoundland and Labrador companies would gain tremendous benefit from deep-water developments in Nova Scotia as well as in Newfoundland and Labrador. Indeed, I suggest we should encourage more such corporations, not fewer.  Two deepwater plays would, in fact, de-risk the long term outlook for Canadian offshore companies who, by and large, are situated in St. John’s.

A joint lobby by the coastal provinces to use HHC revenue for deep-water exploration would perhaps increase the likelihood of a positive result.  The increased revenue from the deep-water exploration could help the provincial coffers of NL, NS, and the federal government. 

3.       Income Tax
The province has increased taxes on the highest earners.  The author is in agreement with this tax increase.  However, I am not an advocate of additional increases in income tax. 

4.          Raising Minimum Wage
The debate regarding minimum wage has existed since Eisenhower implemented the concept in the 1930’s depression era.  I will not go into the debate either way, as there are many excellent papers reflecting arguments, for and against, easily available upon a quick Google search. 
Newfoundland and Labrador has some unique challenges which, in the opinion of the author, justify an increased minimum wage.  I would recommend an increase to 15 $/hr.
Other fiscal conservatives might decry this position.  They would argue over the loss of competiveness and its impact on job growth.
A higher minimum wage likely will have an impact on job creation.  A massive increase in minimum wage might even result in the disappearance of some minimum wage jobs.  But, in future, this province will be challenged to find sufficient people to fill those low paying jobs.  Presently, we struggle to get people on social assistance into the work force.  We find it hard to attract and retain immigrants. 
Such a drastic increase in minimum wage would help overcome both these challenges. Naturally, the measure would substantially improve the purchasing power for those people whose career depends on the minimum wage.  In turn, it will help the economy and increase tax revenue to the province. In addition, precisely because an increase in minimum wage will help attract immigrants, it should be a key part of the province’s population growth strategy. 
There are those who will argue that minimum wage will hurt business.  They forget that, in the global sense, Newfoundland is not a cheap labor jurisdiction.  We will never be able to compete with China, Vietnam, Malaysia, or the southern United States, when it comes to wages.  This is not 1996; cheap labour should not be a cornerstone of our economic diversification efforts.
A problem of far greater concern is that Newfoundland and Labrador suffers from a massive problem of competitiveness. The issue is not related to our minimum wage level.  Indeed, there are many other deep rooted reasons for our loss of global competitiveness.  I would recommend the reader study the excellent report recently generated by the Conference Board of Canada report on the subject. 
One of the most intractable problems, exhibited by graphs contained in the Conference Board of Canada report, is the alarmingly low amount of business expenditures on R and D in the province.  Despite numerous government programs to stimulate R and D spending over the years, the business community’s record remains deplorable.  This problem cannot be blamed on minimum wage workers.  Lack of R and D uptake sits squarely with the managers and owners of business. 
Plenty of reasons abound to consider raising the minimum wage a progressive move.  I suggest a $5 an hour increase can be implemented over the next 5 years. 

 I submit, in the most polite terms, the ideas presented here are modest.  Worryingly, there are limited opportunities for new revenue generation in the province.  
Readers are encouraged to submit their ideas in the comments section.  
Finally, I would add it should be clear to all that the fiscal imbalance will not be corrected by increasing revenue.  That problem will require a fundamental change in how the province spends public money. 
Part VI of this series will examine some areas where spending controls might be implemented. 
 Editor's Note:
"JM" is a researcher and writer.   He is a frequent contributor to Uncle Gnarley Blog offering analysis of the Muskrat Falls project and on other issues, including the fiscal position of the Province. 

JM's essays include: IN NALCOR WE TRUSTDelusion and Deception (Part III)and The Snow Job (Part I).  The very latest Posts, on the 2015-16 provincial Budget, include IT'S THE SPENDING STUPID and The Budget Colloquy (Part 1): Put Him In The Round Boat Til He's Sober,  The Budget Colloquy (Part 2) Revenue Projections: Close Your Eyes, Make a Wish, Hope for the Best and The Budget Colloquy (Part 3) Whistling Past the Graveyard No More.  Having chosen to retain his anonymity, JM is prepared let his articles be judged on the research and argument each contains.