Minority stalemate fears overblown: economists

There are likely few Canadians surprised by last night’s Conservative victory in the federal election, as polls had been predicting it from the start of the campaign. What may have come as a surprise, however, is just how small of a minority Stephen Harper finds himself leading.

Last week there had been some predictions that the Conservatives might even win a small majority, but according to Elections Canada they only managed to win 124 of the 308 Parliamentary seats up for grabs. The Liberals were not far behind with 103 seats.

So far the markets have offered a mixed and only slightly negative reaction, with Canadian dollar trading falling 19 basis points overnight to 86.81 cents US, and a mildly bumpy start for the TSX. Traditionally, minority governments are seen as a negative, as the governing party struggles to push through its agenda.

“I think markets are wrong about the assessment that majorities should lift the dollar and the economy and that minority governments are ‘bad’ — I think that’s old-think,” says Don Drummond, senior vice president and chief economist at TD Economics. “When we had deep fiscal problems, you needed a government with a clear mandate to address it, but that’s not the environment today.

“A new government will hopefully make improvements on the economy, but there’s not some crying need for a dramatic shift in policy direction that somebody needs a majority mandate to do,” he says.

Economist Dale Orr, managing director of Global Insight, agrees that a minority government is not the end of the economic world.

“It doesn’t matter that it’s a Conservative minority, at least for the next little while, because the Liberals will not want to tumble us into another federal election,” says Orr. “Our assumption is that the Conservative platform will be in play for at least the next year. I think this government will be able to persevere with their program until the Liberals get their new leader and get ready for a new election.”

Jim Stanford, economist at the Canadian Auto Workers union, points out the three opposition parties are all politically center-left. He hopes this will “keep a tight rein on some of (the Conservative’s) kookier ideas.”

“Even in a minority situation, I suspect the Tories will move ahead with some of their central economic proposals,” he says. “I think they will move ahead with the GST cut, but they may not try to move ahead with the capital gains tax elimination, because that would be more controversial and give the opposition parties more of a political platform.”

Stanford suspects the Conservatives will move ahead with their decentralization plans, as they can likely count on support from the Bloc Quebecois.

While it would be difficult to paint the Liberal Party of Canada as “anti-business,” the tax changes proposed by the Conservatives have certainly caught the attention of the business community. One of the most dramatic tax proposals has also been among the vaguest of the Conservative promises: the elimination of capital gains taxes if the capital is reinvested within six months.

“It’s really difficult to say what the fiscal costs might be, because we don’t have really good data on how much the federal government is collecting in capital gains,” says Orr. “We understand it to be about $2 billion a year, but certainly the amount would vary an awful lot from one year to the next.”

If the proposed changes to capital gains taxes are adopted this year, Orr suspects investors would immediately take advantage of it, as many are currently sitting on capital gains derived from the past few years of rallying markets. The proposed changes would allow investors to sell off their holdings in energy, for example, secure their capital gains and reinvest without facing taxation. If that is the case, there could be a short-term drop in the equity market.

“There would be a bit of a front end loading in the response to this,” says Orr. “I expect what would have to happen is that the Conservatives keep their options open on this one. They can’t really afford more than $150 million a year for this and I don’t think they have a very good idea of what the costs might be, but there could be people in the department of Finance who could be pretty helpful.”

He says the potential for more frequent trading will certainly mean the changes are friendly to the brokerage community.

“I think that will be a very big change to the investment environment, possibly making equities more attractive than fixed income and probably more attractive than income trusts,” says Drummond. “I think it will sharpen the rule of thumb that you keep equities out of your RSP and fixed income inside.”

A related tax proposal garnered far less attention during the campaign: the elimination of capital gains tax on equities donated to charity, a promise which Drummond calls a “sleeper.”

“I think there will be a big response to that,” says Drummond. “This is just straight ‘no capital gains on stock donations to charity.’ It’s not costing you anything relative to the initial cost of the investment.”

“It means more than 50% of the true cost of that charitable giving is borne by the general tax-payer as opposed to the person making the actual charitable donation,” he continues. “It’s one of the sleepers in their package. There are a lot of charitable foundation funds that have been set up recently, so it’s becoming a hotter topic and I think this will capture a lot of interest.

Another central promise was to immediately cut the GST to 6%. This would be paid for by rescinding Liberal tax-relief for the poor, lowering the basic personal amount, while raising the lowest tax rate back to 16% from 15%.

Orr says the very lowest income earners with earnings fall short of the basic personal amount, will derive a small benefit of a few dollars a month from the Conservative plan, as they would pay less GST. But he admits these people are not likely spending much of their meagre income on items subject to GST.

For those earning more than the basic personal amount, the Conservative tax plan will mean higher taxation on income.

“Once you get through that basic personal amount, for every $100 that it’s lower, these people would have had $16 more under the Liberals than the Conservatives,” he says. “That lowest bracket goes right up to $36,000, so those are still relatively low income people and they would have had more benefit from the Liberal income tax proposal than under the Conservatives.”

One Liberal policy the Conservatives have promised to follow through on is the Liberal proposal to change the dividend gross up rate on the dividend tax credit, Drummond points out. On average that should cut the federal-provincial tax rate on dividend income from 31% to 26%.

“We’ll see if the provinces match that to take it down further,” says Drummond. “It’s just another thing that will make investing in equities more interesting.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(01/24/06)