Canadian Imports and Trade Issues - Example

Bank of Canada (Name) (Institution) (Grade/course) (Instructor’s Name) November 12, 2009 Introduction The Bank of Canada was created in through an act of parliament in 1934 and started operations inn 1935. An amendment to the act in 1938 nationalized the institution whereby it took up some roles of the department of Finance and also took all receiver General Offices across the country. The bank is charged with a number of roles chief among them provides liquidity to the system Acts as the government’s chief financial adviser oversees major clearing and settlement systems Acts as the government’s and the country’s financial system banker Works in collaboration with other regional and international bodies in financial matters (Bank of Canada, 2009). In its capacity as the chief financial adviser to the government, the bank is served with the role of guiding the economy. As such, key economic indicators such as inflation and GDP growth are used to measure the effectiveness of the bank’s financial policies. Over the last two years, the global economy has been undergoing a financial crisis that has not spared the country. Unemployment levels have increased, inflation, energy prices have shot up, house prices have crushed and the economy is generally in a bad shape. In the third quarter of 2007, the GDP grew by a mere 0.8% on a quarter-to-quarter basis compared to the previous quarters as 3.0% (3rd), 3.8% (2nd) and 4.0% (1st). This paper will thus assess the Banks success and failures in maintaining appropriate and acceptable levels of income taxes, any taxes they supply side policies, monetary policies, quantitave easing, any interest rates Income tax In an effort to stimulate the economy according to the banks’ governor, Mark Carney, the Bank employs a number of fiscal and monetary policies depending on the prevailing economic conditions. Some of the ways through which the bank employs these policies are through regulating government spending, regulating taxes (fiscal) and regulating interest rates (monetary). Fiscal polices are directly implemented by the different levels of government in the country with advice from the bank while monetary polices are implemented by bank. Consequently, taxation polices tend to vary from one territory government to the other or among local governments. In most cases, the federal government’s policies override the territory and local government’s polices. Mankiw (2008) argues that the lowering of corporate tax in any given economy increases money supply in the economy. He says this happens as the government places more money in corporations so that they can plough them back into their operations. On the other hand, critics of tax cuts argue that they only serve to enrich the already rich as they are the one who the highest taxes. As such tax cuts are a burden to the government as they imply reduced revenue. Taussigs (2007) investigates the relationship between income taxes and economic growth by assessing extreme cases. He says that if taxes were non existent, 0%, individuals would be highly motivated as what they earn, they get to keep all. The economy would grow as firms increase their investments and inventories by investing back all their profits. Industries would however, be inefficiently regulated due to governments inability to run its programs. The economy would suffer in the long run as firms get caught up in unfair competition among other economically unhealthy practices that impact negatively on the economy. He thus theorizes such as situation is impossible. On the other extreme end, 100% income tax rate would imply that any earnings by firms or households, the government takes all. The government would have all the money to run its programs. Unfortunately, there would be no motivation to work. Firms would have nothing with which to run their operations, there would be no investments. Individuals would be inclined to seek ways to survive that would not result in financial earnings. For instance, small scale agriculture in hidden land would be the norm. Additionally, firms would devote resources into hiding their profits and outputs from the government and evading taxes. In general, this leads to economic stagnation. This relationship between economic growth and taxes is best explained by the Laffer curve (Appendix, A) which shows that 100% taxation leads to 0% GDP growth and vice versa (Laffer, 2004, Taussig, 2007). The government has therefore to strike a balance in financing government operations through taxation and at the same time motivating individuals and firms through low taxation and provision of essential services. In the last two years, the Bank of Canada has been formulating tax policies in response to prevailing economic conditions. The recent tax cut was in response to a slowing economy growth rate of 2.7% as of 2007 compared to the previous year at 2.8%. With the US being Canada’s biggest trading partner, economic trends in the US heavily influences economic policies and trends in the country which are heavily linked with the decreased growth in the lat two years (Reynolds & Nelson, 2008). According to Reynolds and Nelson (2008), foreign trade accounts for 40% of the country’s GDP. With the US undergoing a recession, Government revenue in form of foreign trade decreased leading to a drop n GDP to 0.8% in the fourth quarter 2007. Conventionally, the government would seek to increase taxes in order to maintain its levels of revenue. But is this economically viable? Is this what economic theory suggests? As earlier discussed, the government has lowered corporate and income taxes. The government has also been actively “streamlining cross-border tax-withholding and return-filing rules” (Strengthening Canada's Tax Advantage, 2009). Other forms of tax cuts have been in forms of relief. These are; Home Renovation Tax Credit- This ruling allows tax relief to a maximum of $1,350 to an estimated 4.6 million Canadian families. It also recognizes first time home buyers by offering them up to $750 in tax relief. Personal income tax relief- Starting on January 1 2009, the 2008-09 budget allocated $20 billion for personal income tax relief over the next five years. This included raising the threshold for taxation in order to financially empower low income earners. Working Income Tax- In a bid to encourage Canadians to retain their jobs, the Working Income Tax was doubled. This in effect allows the jobless to such for employment and the employed to stick with their employers thereby providing stability for the economy and the job market (Strengthening Canada's Tax Advantage, 2009). Increase in taxes is considered to be contractionary. Such measures are meant to slow down vigorously growing economies to avert inflation (Mankiw, 2008). As such, an injection into the economy would stimulate growth through increased money supply in the economy. In the case of the Canadian government, the slowed GDP growth saw the Bank of Canada introduce several tax cuts. Corporate income tax for Canadian-controlled private corporations declined from 12% to 11% as of January 2008. In 2007, the federal government issued a directive, through the advice of the Bank of Canada to lower the general corporate income tax from 22.5% to 19.5% which is expected to be lowered further to 15% by January 2012. This will increase money supply in the economy and allow firms to make more investments and create jobs (Strengthening Canada's Tax Advantage, 2009). Quantitative easing As a member of OECD, Canada was supposed to increase its government spending by about 2% of its GDP to ease the effects of the global recession. Mankiw (2008) says that governments have no trouble in increasing money supply in the economy but the trouble is the manner in which to do it and the effects it has on the economy. The Bank of Canada advices the government on the best ways through which to increase money supply in the country through government programs such as road building, railway line construction among others. In the last two years, the federal government has increased government spending in civil works. Through the stimulus package amounting to 1.9% of the GDP, the government has allocated $12 billion in infrastructure construction this year as part of the larger $400 billion earmarked for the same in the next two years (Canada News Center, 2009). In December 2007, the Bank of Canada lowered its overnight lending rate by 0.25% to stand at 4.25%. This move increases the amount of deposit available for banks to lend out. As such, it aims at increasing the amount of money circulating in the economy. The economy has recorded an average of -0.5% growth in the past few months of 2009. Fortunately, the economy has avoided a full blown recession like the case in the US and other economies due to Canada’s relative strength of the banking sector and an increasingly active job market. The recession however is being blamed on falling volume of foreign trade, falling consumer confidence and subsequent unemployment. The Bank of Canada has not employed quantitative easing as one of the unconventional ways of stimulating the economy in the last two years as of May this year according to the Deputy Governor John Murray. Murray (2009) says “The Bank of Canada has not engaged in credit or quantitative easing, but has made a conditional commitment regarding the future path of the target interest rate” (p, 7). This practice is also mistakenly referred to as printing money. However, it involves bank purchasing private or public sector securities by expanding its reserve base. The basic idea behind this policy is to exert downward pressure on interest rates of securities and at the same time exert upward pressure on their prices. This is effect creates optimism in the securities market as an integral part of the economy. The process also injects additional “non-existent” reserves the bank which can be transferred to the financial system as deposits. In essence the process injects money in the economy out of nothing through a created illusion of money but the actual printing of money does not take place (Murray, 2009). Interest rates In a free market such as Canada, the government cannot regulate interest rate levels directly. As such, the government through the Bank of Canada can only regulate the rates through the overnight lending rate. As the lender of last resort, the bank sets the rate in order to achieve target interest rates and also control inflation levels. As of October, the rate stood at 0.25% as targeted. The availability of interest rates directly determines consumption in the economy and the direction of aggregate demand. Higher interest rates encourage households and firms to save to enjoy the high tax rates. Conversely lower interest rates encourage households and firms to spend thereby creating an increase in general demand which leads to economic growth. However, very low interest rates lead to oversupply of money in the economy and eventual inflation which hurts economic growth. As such, the bank may create money out of nothing through quantitative easing as shown above. Monetary and Supply side policies Supply side polices as compared to demand side policies work on fighting inflation, lowering unemployment, improving GDP growth and ensure a positive trade balance with foreign markets. These policies tend to call for minimal government intervention and hence the Bank of Canada as any other central bank plays a facilitating role. The most effective supply side policies employed are as follows. a) Privatization This refers to the transfer of specified public activities to the private sector. This is important in order to increase efficiency as the private sector is driven by profits and tend to be more efficient. On a financial note, privatization is carried out to minimize government budget deficit. In the case of British Columbia there have been attempts to privatize the regions health care services much to the resistance of the public. For example, employees of Royal Inland Hospital have resulted into a spirited resistance for the hospital to be privatized (Care2petition, 2009). b) Deregulation of markets (e.g. financial, property, labor etc) This entails reduction of barriers to entry. Such measures may include fewer processes in business registration, abolition of monopolies and lowered import tariffs. The government has made no significant changes as shown by the raking (8) of the country in the ease of starting a business in the ease of doing business list in the last two years. However, the ease has remained among the highest in the OECD category (Doing business, 2009). c) Increased education and training and job information The government has increased the budget allocation for education in 2009 chief among them the Consolidated Canada Student Grant Program. In the 2008 budget the program was allocated $350 million starting in the fall which is to be increased to $400 million in the 2012/13 financial year. This is just one among the many programs that are being used to implement supply side polices. In the long run, the programs improve the competitiveness of the Canadian public in the domestic and international labor market thereby increasing productivity (Economic Leadership Investing in the Future, 2009). d) Improving transport and infrastructure The Gas Tax Fund was introduced to finance local municipalities in their planning efforts. The fund, $2 billion is permanent is not thus part of the stimulus package which is temporary to offset the current recession (Canada News Center, 2009). Conclusion Through the various activities of the Bank, the Canadian economy has managed to go through the global recession only sustaining minor decline in the economy. As of October, inflation levels were -0.9% and GDP growth rate at -0.1%. Comparing this with other OECD countries such as the US, then the bank of Canada has performed exceptionally well as the financial adviser of the Government. In essence, the bank’s policies have been successful. However, the structure of the Canadian government through the presence of different levels of governments impact on the effectiveness some of these polices are. For instance Quebec has its own tax filing systems while other regions rely on the federal government to carry out the tax filing. References Bank of Canada (2009).Bank of Canada lowers overnight rate target by 1/2 percentage point to 1 per cent, (Retrieved online on 12th Nov from), http://www.bank-banque-canada.ca/en/fixed-dates/2009/rate_200109.html Bank of Canada (2009). Economic Leadership Investing in the Future, (Retrieved online on 12th Nov from),http://www.budget.gc.ca/2008/plan/chap3c-eng.asp Canada News Center 2009, Over $400 M in infrastructure spending rolling out for projects from coast-to-coast-to-coast, (Retrieved online on 12th Nov from), http://news.gc.ca/web/article-eng.do?crtr.sj1D=&mthd=tp&crtr.mnthndVl=&nid=442239 CBC News (2009). Canada heading into 9-month recession: Conference Board, (Retrieved online on 12th Nov from), http://www.cbc.ca/money/story/2009/01/14/conference-board-outlook-january.html Care2petition, 2009. Say "NO" to Privatization, Protect Health Care Services, (Retrieved online on 12th Nov from), http://www.thepetitionsite.com/3/say-quotnoquot-to-privatization Doing business, (2009). , (Retrieved online on 12th Nov from), http://www.doingbusiness.org/ExploreEconomies/?economyid=35 Mankiw, G. (2008). Principles of macroeconomics, 5th ed New York: Cengage Strengthening Canada's Tax Advantage, (Retrieved online on 12th Nov from), http://www.budget.gc.ca/2008/plan/chap3b-eng.asp Murray, J. (2009). When the Unconventional Becomes Conventional: Monetary Policy in Extraordinary Times, (Retrieved online on 12th Nov from), www.bankofcanada.ca/en/speeches/2009/sp190509.pdf OECD (2008). OECD Economic Surveys: Canada 2008, OECD Economic Surveys, Volume 11, OECD Publishing Reynolds, M. & Nelson, J. (2008), Canadian Imports and Trade Issues, Quebec Nova Publishers Taussig, F. (2007). Principles of Economics, Volume 2, New York, Cosimo, Inc Appendices A. Laffer curve Source: http://www.heritage.org/Research/Taxes/bg1765.cfm B. The current and proposed tax brackets for 2009 are as follows:   Tax Rate 2009 Tax Brackets   Pre-budget Post-budget 15% Up to $38,832 Up to $40,726 22% 38,833 – 77,664 40,727 – 81,452 26% 77,665 – 126,264 81,453 – 126,264 29% 126,265 and over 126,265 and over source http://www.kpmg.ca/en/services/tax/tnf/tnfc0906.html C. Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2009 1.10 1.40 1.20 0.40 0.10 -0.30 -0.90 -0.80 -0.90    2008 2.20 1.80 1.40 1.70 2.20 3.10 3.40 3.50 3.40 2.60 2.00 1.20 2007 1.10 2.00 2.30 2.20 2.20 2.20 2.20 1.70 2.50 2.40 2.50 2.40 2006 2.80 2.20 2.20 2.40 2.80 2.40 2.30 2.10 0.70 1.00 1.40 1.70 Source http://www.tradingeconomics.com/Economics/Inflation-CPI.aspx?symbol=CAD Read More