Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 9 - Evidence, September 30, 2009
OTTAWA, Wednesday, September 30, 2009
The Standing Senate Committee on Banking, Trade and Commerce, to which was referred Bill S-203, An Act to amend the business Development Bank of Canada Act (municipal infrastructure bonds) and to make a consequential amendment to another act, met this day at 4:20 p.m. to give consideration to the bill.
Senator Michael A. Meighen (Chair) in the chair.
[English]
The Chair: I am sorry we are late, but we were stuck in an elevator and only got out due to the ingenuity of Senator Harb and Senator Grafstein who used their house keys to pry the door open. I will remember that for the next time I am shut in an elevator.
Before beginning, I want to extend a special welcome to Senator Frum, who is joining us for the first time as a member of the committee.
Welcome, Senator Frum. I hope you will enjoy the experience. You will find that this is a pretty collegial group. It is the best committee going, so we are glad to have one of the best new senators with us.
Today we are examining Bill S-203. This bill was introduced in the Senate on January 27 by Senator Grafstein, our colleague and former chair of this committee. According to the bill's summary, Bill S-203 would:
[Translation]
This enactment amends the Business Development Bank of Canada Act to provide for income tax exemptions for municipal bonds to finance infrastructure projects.
I am confident that the subject of municipal infrastructures is of great interest to everyone, not only here but across the country, given that each one of us uses these infrastructures on a daily basis.
[English]
For our first witness on this bill we could ask for no one better than the sponsor, and I am delighted to welcome our colleague and friend, Senator Grafstein.
Hon. Jerahmiel S. Grafstein, sponsor of the bill: I am delighted to be here to speak to this bill, the subject matter of which has been debated from time to time across the country. The principle has been deeply accepted in the United States. Municipal tax-exempt bonds predate the Income Tax Act in the United States. I will give you some statistics and numbers to compare our system to theirs.
I will start by saying that we are facing very difficult market conditions. The economy continues to be choppy and unpredictable. Since we have to confront a monumental economic and political task, this is a good time for coherent rationale for urban infrastructure renewal and modernization of our cities.
It is facile to say that, as our cities go, so goes our country. The more efficient, effective and competitive our cities are, the more effective our economy is. When the engines of growth in our cities fall apart and are unproductive, it affects everyone across the country. This is a very important proposition of productivity.
Not since the end of World War II, when the federal, provincial and municipal governments all recognized, each in their own way, in their own spheres, the pressing necessity to revamp and modernize our infrastructure has the need been demonstrably greater. A recent study by the Canadian Federation of Municipalities entitled Danger Ahead: The Coming Collapse of Canada's Municipal Infrastructure outlines the staggering cost of decaying urban roads, transitways, water works, garbage incineration and waste management, all in need of instant renovation and requiring investment, reinvestment and modernization.
According to Statistics Canada earlier this year, waste water facilities across Canada have used up to 63 per cent of their service life. Fifty-nine per cent of the service life of our highways has been used up, 52 per cent of the service life of our sewer systems and 49 per cent of the service life of our bridges. We have seen some dramatic occurrences with bridges in the last year; our bridges are falling apart. If anything, there is a crisis of modernization and management.
As our cities grew, the nature of our economic activity changed. Services shaped and polished in our cities are overtaking older manufacturing jobs as growth factors in our economy. That comes from a number of reports, all of which I can make available to you.
Aging city infrastructure contributes to loss of jobs, especially manufacturing jobs. As of earlier this year, and the number is even greater now, in the Greater Toronto Area we had lost in excess of 47,000 manufacturing jobs. We must reverse this slide in value-added manufacturing jobs across Canada.
If honourable senators are interested in the nature of national economies in relation to cities, I ask you to read any one of the recent books on economic history. They include The Rise of the Trading State: Commerce and Conquest in the Modern World by Richard Rosecrance; The Age of Extremes: The Short Twentieth Century by an outstanding leftist economist, Eric Hobsbawm; The Wealth and Poverty of Nations by David Landes.
John Kenneth Galbraith's was an acquaintance of mine and was born in my province. If you look at his economic nostrums you will find valuable support for this proposition. Of course, the exemplar is the late Jane Jacobs, who lived in New York but made her home in the city of Toronto. Examine her classic book, Cities and the Wealth of Nations.
Each of these books has a common thread: Cities are equal to growth. Jacobs, who lived in Toronto and passed away recently, noted in her work, Cities and the Wealth of Nations, that our cities serve as both engines of growth and creativity. One cannot divorce the nation's economic growth from the economic growth of our cities. They are in direct proportion to one another; they are attached like Siamese twins. Cities propel our economic growth in all regions of the country. Value-added products and services for the new and the old economy are tested and marketed in our cities. New cultural products are created and distributed from our city centres and exported around the world.
Honourable senators who were on the banking committee under my chairmanship with the very Honourable David Angus as deputy chair, will recall that we did a study on productivity. We noted that our productivity was in a downturn that was due to the inefficient urban landscape that contributed to an even greater productivity lag, which is currently 15 to 20 per cent behind our American counterparts.
If we are trying to compete in a world of globalization, then the cost of our products, the input and at least our productivity must at least match our North American partner of this continent, and it does not.
It makes our goods more expensive and less competitive in our global marketplaces. In the 2007 report of the Ontario Institute for Competitiveness and Prosperity, they compared our per capita GDP per workers to the United States and showed that the range of productivity in the United States was higher by 20,000 per worker in three states, 14,000 per worker in 14 states, and 1,000 per worker even in Michigan. Even in Michigan, which has probably suffered the most in the current economic downturn, they are more productive by 1,000 per worker in this downturn. I urge you, honourable senators, to read this good study on productivity that we did.
Each time a Canadian travels to work within our cities or produces work, he or she is met with gridlock, and productivity goes down. A study last year noted that Canadian workers now spend 10 days a year commuting to cities. In Toronto, it is higher, at twelve days a year. It means that one day of every month is lost in terms of productivity and prosperity. That is due to traffic gridlocks and road jams.
Our expressways, honourable senators, are misnamed. It is misrepresentation. They are not expressways. Rather being called ``expressways,'' they should be called ``moving parking lots.'' Take a look at the 401 or the Gardiner in Toronto, for example. By the way, that situation is not unique to Toronto. If you look at the entrance and exit to Montreal, Winnipeg, Edmonton, Calgary or Vancouver, you will find there is no such thing as an expressway anymore. It is a moving parking lot. It contributes to pollution as cars are forced to idle on our streets. There is increased cost to businesses, increased cost of fuel consumption and there is lost time. The health of our cities is suffering as a result of being inefficient.
Honourable senators, that has not taken into account the huge pollution costs that are affecting us directly in terms of lost time and cost. As a matter of fact, we have never done a study about that issue. I have urged our city fathers in Toronto to do a study about the cost of slowing down a car in a city in terms of the increased pollution and impact it has on health costs. There is no zero sum. If people get sick, the taxpayer ends up paying the shot. We have to look at cost in all of its perspectives.
Residents of the city pay a higher percentage of real estate taxes for services than do comparable cities in the United States. I have a report, again from the Library of Congress, which says that if we did a comparison of them, property taxes comprise 39 per cent of revenue in Canada, and that figure went up to 40 per cent in 2004, whereas in the United States, property taxes comprise 25 per cent of municipal revenues. We are almost double in terms of the impact we have on real estate costs as opposed to the United States, largely as a result of this financing model that I am proposing to you.
Some of our cities have failed to keep up with capital investments and renovations by way of help from transfer funds from the government. That means that the federal government raises the taxes, and the city spends it. That is irresponsible, in my view. I think that we believe in responsible government, and if money is spent in my city, the taxpayers of my city should be responsible, to a large measure, for those particular costs. It is irresponsible to raise money in one jurisdiction and transfer it to the other jurisdiction, but we have grown to take advantage of that particular model.
There are various degrees of accountability in this method. I say ``accountability'' because this current government has made accountability one of the key pillars of its governance. I do not quarrel with that. There are questions of clarity and transparency for taxpayers in order for them to decide whether their money is being properly spent. Yet, municipal governments estimate that $125 billion will be necessary to renovate the old and new infrastructure.
A recent report in my own city noted that the failure to renovate the city's water system or to keep up with modernization, which is now some 75 to 100 years old to a large measure, has resulted in leaky pipes, so that one third of the water is lost. We pay in Toronto for 100 per cent of the water, but one third is lost because of leaky transmission lines.
Therefore, it seems to me that as more and more people from the rural areas continue to crowd into our cities and as the rural-urban split intensifies, we increase the pressure points on our system. We allow people to come into our cities, but we do not provide for the services necessary for those people.
With regard to the federal government's responses to this problem, I am not referring to the current government. This is systemic to all governments in the last 20 or 30 years. I want to make it clear that the way we have dealt with cities is through handouts, even with respect to the action plan, which is an updated version of this. We deal with handouts. There is a big discussion about transfer points and so on, but what the federal government does is hand out money to the cities. There is no accountability. We send $1 billion to a city, they spend it, they have cost overruns, but there is no accountability, even at the city level. There is a lack of transparency, there is a lack of accountability, and there is a lack of cost effectiveness. Previous governments have done that over and over again, and we repeat it in this plan. This plan of the government is a little more coherent than previous ones, however, because as I studied the action plan, as far as the agreements that have been devolved, the federal government is at least asking for partial accountability for some of the infrastructure money that is being donated. That is a good thing. One of the reasons the plan has been delayed — which it has been — is that as they enter into these agreements, cities are reluctant to put their money where their mouth is. If we take a look at the delay in the Canadian action plan, as I have in Ontario and in Quebec, you will find that it is the agreements of accountability that slowed the process down.
The government is trying, but it is not doing a good job because now we talk about the handouts. We need $125 billion for current renovation, and if look at the municipal report, there is another $125 billion for new plants in the next 10 years. We need $250 billion in the next 10 years to renovate and keep our cities up to date.
What are we spending from the federal government? The federal government, prior to the action plan, promised $33 billion in episodic handouts across the country. That works out to nearly $1,000 per Canadian over seven years. I have tried to find out whether the $33 billion over the seven years promised to the cities by the federal government has been changed, but I cannot give you an exact analysis. On page 16 of the Canadian action plan that was tabled just a few days ago, they say that they are now spending $9.6 billion. If the previous promise was $5 billion, there is now $9.6 billion over the next two years, which is still, in my view, small and inconsequential. That does not even come close to the $125 billion. To be fair, that does not include the contributions that the cities or the provinces make to this plan. We are far away from the $125 billion, which would be the minimum target required over the next 10 years.
Where can we get this money? When confronted with the choice of modernization after World War II, the Liberal government led the way by a massive investment to build the St. Lawrence Seaway, which was a spinner of economic growth and continues to be. Following that, the TransCanada Highway was amplified by a magnificent program laid out by Mr. Diefenbaker. Both programs were great objects of productivity. After the war in the 1950s the provinces built expressways, new commuter links and subways. We have not caught up to that speed of growth since that time. From 1946 to 1955 was a magnificent period of modernization, but after that we fell behind.
What to do? Can we learn from some of the best practices of our American neighbours? They have had municipal tax exempt bonds, before income tax, since 1893. If you want know how to invest them or why to invest them, you have only to pick up a copy of the Wall Street Journal or the New York Times to find them listed in detail right across the country. Let us take a look at how it works in the U.S. for financing not otherwise available or affordable for urban projects, all with revenue streams. It is important to understand that not all the projects of cities are financeable. However, water systems, toll roads and transit systems are financeable. It is not a total devolution from one system to the other. It focuses on those activities within the city that have revenue-producing numbers, such as hydroelectricity.
In the United States, it shows that for every $1 of tax-exempt bonds, 67 cents goes into reinvestment in municipalities and the other 33 cents goes to the tax-exempt bond holder. Interest costs in the United States vary from city to city and from project to project. They are based on the city's track record of accomplishment to meet their goals within a reasonable period of time, which is good business practice. Bond rates are lower if the project is completed on time, thereby forcing a city, for the first time, to be accountable project by project to the taxpayer and, in this instance, to the tax-exempt bond holder.
Recent reports in the United States note that U.S. municipal bonds have a great value, rivalling U.S. treasury bills. In the U.S. one would expect the trillions of dollars of new public expenditures would crowd out municipal bonds, but that has not happened. That raises the question: Would such a system here crowd out federal or provincial bonds? I do not believe that would happen. Currently, there is $1 trillion waiting to be invested by Canadians. Canadians are sitting on $1 trillion because they are concerned about the market. This is the highest pool of capital that we have ever seen sitting in bank accounts in short-term notes, long-term notes and federal bonds. Investors want security so they are saving their money and not spending it. A huge pool of $1 trillion is ready to be tapped for a project of this nature. In the United States at the end of 2005, there was U.S. $2.2 trillion invested in municipal tax-free bonds. If Canada had one tenth that amount, in keeping with our population differential, we would have at least $200 billion in municipal tax-free bonds available, which is close to the number that the municipalities think they need over the next 10 years. That was in 2005. The latest number I have is $2.7 trillion in 2008, and it is still on the increase. Despite the credit crunch and the economic downturn, Americans are still investing in tax-free bonds.
I have provided the numbers about our rapidly deteriorating infrastructure. By way of comparison, in the 1930s, there was census to construct bridges and update infrastructure in New York City, which was falling apart. Governor Roosevelt of New York State appointed a man by the name of Moses, who created a fresh way of financing the work. In New York City, one of the great metropolitan areas of the world, you will find toll roads and toll bridges, which led to the growth of New York City. There is a direct relationship between those toll roads and that efficiency within the city to its growth as an accessible place. Much of it is falling apart and will need renovation but it stood as an exemplar of what to do.
In Boston, it took 20 years to build an underground tunnel and bridge way on a revenue-driven basis. Today, Boston is one of the most modern and efficient metropolises in the United States.
It is important to take a look at successful Canadian projects, such as Highways 401 and 407. Highway 407 is a toll road constructed to bypass Toronto. The Gardiner Expressway, which is a disaster, could be open to tolls. In 1972, the federal government under Mr. Trudeau, gave some harbour front lands to the city for renovation. Part of that plan was to ``chunnel'' the Gardiner Expressway. Under the current circumstances of handouts from the federal government, it could not be done. However, it could be done on a revenue-driven basis. The key innovator in chunnel technology is in Toronto. The leading innovator in chunnelling technology is in Toronto but we have never been able to utilize that technology for our own city.
An expressway from Union Station to the Pearson International Airport has been approved and announced eight times. Currently, we have right-of-way that has been in place for 70 years. I attended each of those eight announcements — three by the Chrétien government, three by the Martin government, and two by the Harper government — but it has not been built because there is no money to build it. Toronto is the only modern city in the world that does not have an express train from downtown to its airport. This could be tolled and built easily with these exempt bonds.
Honourable senators, the system is very cost efficient. My proposal would be to change the name of the Business Development Bank to the Business Development and Urban Renewal Bank. There would be a separate division set up under the bank with offices across the country. Any municipality could apply for a tax-exempt loan. They would first have to go to their province. The province would have to sign off to indicate it has looked at the numbers, statistics, your ability to meet your targets and they would agree. It would then go to the bank. The bank would do its due diligence and advance the money as money is being advanced today by any bank in building a high rise building or any type of infrastructure project. It would be carefully controlled and the money would then be tax exempt.
What would be the cost to the federal government? Take $100 billion and assume the average interest rate at this particular juncture would be 5 per cent. It would be a boon to investors now getting less than 2 per cent from their banks and a very low percentage from government treasury bonds. It would be a boon for Canadian investors to participate. The cost to the federal government would be $2.6 billion per year. That would be the cost of revenue lost, rather than the $9.5 billion. Part of that money already allocated by the federal government would be a revenue loss, which would make the amount of money available for the grants $2.3 billion less for $100 billion.
The federal and provincial government would get that money back within a year. How? Think about the leverage. You put up $2.3 billion and get $100 billion in capital expenditure. Think of the spin-offs in jobs, tax returns and harmonized tax. The money would come back within a year if it was all spent in that year. There is virtually no cost.
However, there is a flaw in the plan. It is based on the experience of Ontario, which tried opportunity bonds. It did not work because it was not well thought out. Those of you familiar with the bond market will know this. A small market of $1 billion or $2 billion is not large enough to attract liquidity in the marketplace.
There are no experts in this area. The business community has a mixed reaction. I hope you will introduce evidence to see where they stand.
At the end of the day, I have heard only two arguments against this proposal. First, the initial pool must be large enough — no less than $5 billion, preferably $10 billion — to create a marketplace that would be unique. That would not be a problem. Second, the argument is crowding out. Somehow, $100 billion of new investment would crowd out either tax exempt provincial bonds or federal bonds. If you look at the American experience, that falls to the ground.
The most recent indication in the newspapers is that Canadians are holding on to $1 trillion. I would bet that people would invest in a bond in their own city for 5 per cent or 6 per cent and half of that would be tax exempt.
Honourable senators, I am not being critical of the government. This plan would not impede or interfere — in any way, shape or form — with any existing government plans. It would be an add-on — something new and different.
If we tried it to the extent of $10 billion or $15 billion, it would pay off in spades very quickly. It would allow our cities to plan. Currently, cities cannot plan; there is no such thing as planning. Those of you who are experts on cities and who have been investing in cities as some of us have know that they cannot plan.
We do not have a subway system in Toronto. We used to, but we do not have a system because we have not done any add-ons for the last 25 years. We have some street branches, but no subways. There is not one great city in the world that does not have a great subway system. Toronto could be one of the great cities.
Forgive me if I use Toronto as an example. It could apply to Vancouver or Montreal. It certainly could apply to the new growth cities of Calgary and Edmonton. Without a great subway system, you do not have a great city. The two go hand in hand.
I commend this project to you, honourable senators. Time is of the essence. I look forward to your questions and thank you for your indulgence.
The Chair: Thank you, Senator Grafstein. We started late as I noted, so we will continue past five o'clock as far as we can go to allow enough time for our second set of witnesses. Let us try and keep the questions crisp. I know the answers will be crisp.
Senator Greene: First, I agree that we have an infrastructure problem in this country. That, however, is true of many countries, including the United States, which has had these bonds for a long time. Arguably, their infrastructure problems are worse than ours as you will know if you have driven in California and elsewhere.
The presence of these bonds in the United States has not been the vehicle to enable them to solve their infrastructure problems. It is, perhaps, one of many. However, it is not a panacea in any way, shape or form. That is the presentation you are making and I am simply not comfortable with that.
With regard to the United States, a recent report by the Congressional Budget Office is concerned about the cost of these bonds on the U.S. treasury. It makes recommendations with regard to capping them, limiting their use and even making them not tax free — perhaps offering a tax credit instead. If the bonds were successful in the United States, perhaps they could be something we could look at. However, it seems to me that they are not successful.
Senator Grafstein: Let me break down your analysis in two ways. First, I agree with you. This bill is not a panacea. I thought I was careful to suggest — maybe I did not make it clear — that this is not to replace anything else we are doing. This is an add-on; this is supplemental. It can be tried and tested without interfering with the system in any way, shape or form. If it works, it works and if it does not, it does not. A $10-billion or $20-billion outlay of tax exempt bonds would not impede anything. It would accelerate modernization.
Second, Senator Greene, I disagree with you. Looking at the United States, if they did not have tax exempt bonds, they would be in worse condition than they are. There are model cities. Mayors that I have spoken to in the United States think this allows them to plan.
The current system in Canada does not allow a mayor to plan. We have a mayor of the largest city in Canada. He cannot plan beyond one year or two. He can make a plan, but he cannot facilitate the financing. This allows them to plan.
It is cost efficient. If you can start out by deciding to build 20 kilometres of subway over the next 10 years and get the funding in place, you are immediately able to save.
Each time a mayor has to undertake a new infrastructure program, he has to start from zero-sum and worry about the funding. It recently happened where the mayor of Toronto went against the action plan in the stimulus package and asked for money for streetcars that were not to be delivered until 2017 or 2018 at the earliest. The federal government rightly turned it down because it did not meet the stimulus package objective to create jobs in the short run.
I have been a great critic of our mayor for many different reasons. However, in that instance he was trying to plan ahead. He coerced the provincial government and the federal government now to give him money over a long-term period. The federal government does not have enough money to do the renovation. It does not have the leverage. There is no leverage in the existing system.
This is a system of leverage. You understand it and I understand it. It is not a panacea. It is not dangerous. It could be tried and tested on a limited basis. If it works, that is great.
If this system were opened up, you would find every major city in Canada lining up to renovate their cities. There would not be a city that would not be knocking on the door to get some of these tax free bonds. The cost to the taxpayer is de minimus.
Senator Greene: In the U.S., they believe that it costs the treasury too much now.
Senator Grafstein: If you compare our system to that of the United States, theirs is fast. It went from $1.7 trillion about seven or eight years ago to about $2.7 trillion and it is closer to $3 trillion now. I am not suggesting anything close to that. If you take a look at $1.7 trillion, 10 per cent of that would be more than enough to cover our things. It is nowhere close to that. My model would be $100 billion, plus the grants. That would put us back on the modernization map. It would make our country more effective and efficient. We are losing jobs as a result of this today, in Toronto, in every sector.
We have a crisis of moving from the old economy to the new economy. This will help. If someone has a better idea, I have not heard it. I just heard about the sparseness of the investment that the federal government is making. I am not critical of the federal government. They do not have the resources to do this or to allocate it in this fashion. Give me a better alternative. This is the best one I could come up with.
Senator Massicotte: My question is quick. If the answers are short, we will get a lot covered.
First, what you are proposing is exemption from federal income tax, not provincial income tax, is that correct?
Senator Grafstein: Right.
Senator Massicotte: In the United States, it is exemption from state tax or only federal tax?
Senator Grafstein: It varies. It depends upon the state.
In Ontario and in other places there is a harmonization tax. If the federal government decided to do this, I could not see the province not doing so.
Senator Massicotte: They could choose to do so?
Senator Grafstein: They could choose not to do so. The difference here is that cities could not make an application to the bank unless the province signed off. The province would have to do an assessment before they approved it.
Senator Massicotte: About the issue of the bond, is there an implicit guarantee by the provinces for repayment?
Senator Grafstein: No.
Senator Massicotte: You also referred to the American example. You seem to suggest that the guaranteed repayment of the bond is based upon the success of the project and not of the rating of the municipality or of the city?
Senator Grafstein: The ratings depend on the project and some of them are stand alone projects. Some of them are municipal projects and they rely on the covenant of the city. It varies project to project.
Senator Massicotte: I have done a couple of those and the city always guaranteed repayment, but there may be exemptions.
Senator Grafstein: If there was an independent authority for the transit authority, for example, they would be issuing those bonds. The city would guarantee it implicitly because if there was a default, then the transit system would default. There would not be an express guarantee.
Senator Massicotte: No one argues with the infrastructure argument. It is important for competitiveness, and so on. You are suggesting that the Canadian taxpayers subsidize, by approximately 20 basis points, the interest rates on municipal bonds to encourage municipalities to spend more on infrastructure. I am not sure a 20 basis difference will stimulate infrastructure money if the provinces do not buy into it. Why would they agree?
The other problem is a conceptual one. You are asking Canadian taxpayers to fund local projects but your argument earlier was that you do not agree with that. There is not a direct relationship between who pays for it and who benefits from it. If it has a lot of worth, then why do not the municipalities raise taxes? If you look at the world position, there is still room to raise property taxes and to remain competitive. Why do they not have the political courage to raise their own taxes as opposed to asking Canadian citizens to indirectly fund local community projects?
Senator Grafstein: The short answer is that they are already doing it. We are giving handouts. The federal taxpayer is already paying in this bill, in the action plan. For infrastructure, take a look at page 16. It is $29 billion for the stimulus package for 2009-10. If I look at building infrastructure to create jobs, it is $9.6 billion. We are already doing it.
Senator Massicotte: You are suggesting that it be another $2.6 million?
Senator Grafstein: The numbers are moving around. The last number I saw was prior to the action plan. The federal government agreed at that time to spend $33 billion over the next seven years. I broke that down to $5 billion a year. That was changed by this plan, where it took the year 2009-10 to $9.6 billion. They then added an additional $4.6 billion for infrastructure.
Let us say the number is $100 billion. My suggestion would be to forego the $2.6 billion, reduce the number of giveaways and the federal government would be in the same position. However, the federal government would get it back ASAP in tax. That is demonstrable. If you ask any actuary to do analysis, they could do so.
Senator Massicotte: The process to create a municipal exempt tax system is more efficient than giving the money directly because it is federal taxpayer money which you are getting to subsidize local projects. You are saying, ``My method will be more efficient than giving the money away,'' in spite of the fact that it represents is only one-quarter basis points. I do not know enough about tax collection, but which one is more efficient? Is it worth it to cause this whole tax exempt system? I am not sure. That is the question.
Senator Grafstein: With all due respect, I do not think that is the appropriate question. I think your question should be put this way — and I will answer both questions. It is not a question of being more efficient. It is a different model because the money is not there.
Senator Massicotte: When you think of a quarter basis points, 25 basis points on the interest rate would implode dramatically the money people want to invest.
Senator Grafstein: Let us assume it is another 100 basis points. There is still leverage. You are in business. You go to the bank. You invest one dollar and hope the bank gives you $10. I am suggesting here that, for $2.5 billion per year, you could create $100 billion worth of creative activity and modernization. That is the leverage. That is the essence of the plan.
Senator Ringuette: Maybe I missed this from your presentation, but do Canadian cities issue bonds right now?
Senator Grafstein: Some do.
Senator Ringuette: Some. I suppose it would be the big cities. Is Toronto issuing municipal bonds?
Senator Grafstein: Yes.
Senator Ringuette: Which other city?
Senator Grafstein: Montreal and Vancouver do; all the major cities do.
Senator Hervieux-Payette: There are hundreds of them. They all do.
Senator Ringuette: Do you know how much money that they get in investment by those bonds?
Senator Grafstein: I am not familiar with the provisions in other provinces, but my understanding of the situation as it applies to my city of Toronto is that the city can only borrow money for capital projects and they do it on a bonding period. There is considerable money in the marketplace of municipal bonds, but they are not tax exempt. The real issue for cities is whether or not they can afford those particular bonds. That goes into the question of the interest rating. Most of the major cities do have bonds; they are obviously not tax exempt.
Senator Ringuette: You are talking about the big cities to provide and invest in infrastructure, but there are thousands of municipalities across this country that need to invest in infrastructure. What do you propose for all these municipalities that are not able financially or technically to issue bonds? How will they be able to benefit? They will not benefit from this bill. This is specifically for the big centres. It contributes absolutely nothing to the smaller municipalities that, from my perspective, are in greater financial need because their tax base is less than what you would find in a city. You can have a condo apartment building in a city that will generate millions of dollars in tax revenue, but for the same space in a small community, you might generate $5,000 worth of revenue. You still have to bring in water, sewer, sidewalks and streets.
I would certainly like to hear your suggestions with regard to smaller communities, what alternatives there are to help them out. If you want the federal government and probably the provincial governments to subsidize bigger cities again, what compromise are you proposing and what are you suggesting for smaller municipalities?
Senator Grafstein: First, I do not think it is fair to say that the federal government would be subsidizing the bigger cities. It is the other way around; the tax base from the major cities subsidize the smaller cities. Those are transfer payments, and it applies not only between the provinces but also within them.
You make my point; you are supporting my bill. At the end of day, what you are saying — and I agree with you — is the smaller cities do not have the revenue base for their water systems to generate enough money to pay back a bond. I accept that. If this bill were adopted, there would be more money available for the smaller cities than there is today. Right now, if you look at it — you can do the analysis on the action plan — you will discover that the largest percentage of money given in the action plan for infrastructure goes to the big cities.
If, you were to draw from a brand new pool of dollars, which is the tax investor, and you thereby get another $100 billion into the system, more money will be left over in the treasury, both provincially and federally, for smaller cities. It is quite the reverse. This will help the smaller cities.
Put it this way: It is another $100 billion on the table that was not there before, at a cost of $2.6 billion. It allows the big cities to grow, and it allows the federal and provincial governments to come up with the balance of the other money to give to the smaller cities. It is quite the reverse. This helps the smaller towns because it puts more money on the table. Show me another way of doing it.
Senator Ringuette: That is the question I ask you. The issue is that smaller municipalities have a greater need for money.
Senator Grafstein: I agree.
Senator Ringuette: They do not have access to this bond system, yet all Canadian taxpayers, through other means, will again be subsidizing the bigger cities. You do not have an answer for the smaller communities that I am asking about.
Senator Grafstein: But I do. Let me put it this way: There is now presently, subject to the action plan, $33 billion for large cities and small for urban renewal. In addition to that, if you took back $2.5 billion, instead of having $30 billion, you would have $130 billion if the cities applied. There would be more money for smaller cities because there would be more money for infrastructure. Two and three makes five, not three.
I accept your point, but I think it would make more money available for smaller cities. Right now, smaller cities do not get their fair share. They are being squeezed. Big cities are being squeezed, and smaller cities are being squeezed even more. We need new pools of money. This is all about new money coming into the system. I hope I have made my point.
Senator Greene: I wanted to make a point of clarification or to ask one, building on Senator Massicotte's questions. You indicated in the discussion about the Canadian taxpayers subsidizing the projects being the same thing as a handout, which the Canadian taxpayers are involved with. However, are you not in this case actually subsidizing the bond holders, the investors, rather than the projects? That is a different kind of thing than the Building Canada Fund or the action plan.
Senator Grafstein: You just get more money that way.
Senator Greene: I am not opposed to it. I am just asking for how you view it.
Senator Grafstein: It is not a perfect system, but we do not live in a perfect world. At the end of the day, I urge you, if you feel this is not a good plan — by the way, you have raised serious questions that hopefully the department will address. After I listen to the department, I hope to respond to their analysis of the bill.
I also urge you to invite experts. I have spoken to a number of bond people, and some agree and some do not. The Department of Finance is not happy with this proposal. It is easier for them to dispense money than to carry out this plan, but it does not produce the same result. I urge you to call them. It is not a perfect plan but, remember, we live in an imperfect world.
[Translation]
Senator Hervieux-Payette: I would simply like to point out to my colleague, who after all is well versed in the Canadian Constitution, that municipalities are provincial creatures that fall exclusively under provincial jurisdiction.
As far as Quebec is concerned, there is no guarantee that the province will, as you say, sign off on this scheme. If the province of Quebec decided not to come on board, it would be alone in not benefitting from it. A side agreement would have to be negotiated to ensure that Quebec received similar benefits, without the federal government having to get involved. This is an important political decision. I completely agree with your assessment that our infrastructures have fallen into a deplorable state and I think everyone seated here at this table will come up with some solutions.
First of all, as things now stand, no financial institution has, to my knowledge, refused to issue municipal bonds. Currently, the average interest rate on these bonds is between 2 per cent and 3 per cent. Clearly, for municipalities, an interest rate of 5 per cent is needed to attract investors. What this simply translates into is a tax bill increase at the local level.
Second, countries besides the United States have found a way to amass substantial sums of money. Some of you may wince at this, but the fact remains that in Europe, the solution to this problem is a gas tax. Quite simply, in Europe, the price of gas is on average 50 cents higher than it is here. The revenue does not simply go up in smoke. If you consider municipal taxes in Germany or France, you will see that they are generally anywhere from 100 per cent to 200 per cent lower than they are here. These countries have infrastructures in place. They still offer services such as garbage collection. They have very good public transportation systems and their roads are in good condition. They have found a way to collect funds that enables them to offer all of these services to the public. Of course, the same roads are used to transport both the public and goods. Garbage is not trucked 200 kilometres away from a city, but usually incinerated in plants. Water use is also another consideration. The residents of these countries pay for water services, the cost of which is also high.
There are societal models that we can look to for inspiration. Your idea for resolving the problem of municipal infrastructures is a good one.
However, we need to give more thought as to how to put this plan into action. Remember that the federal government has no business intervening in municipal affairs. What advantage would there be for a mayor to issue a $50-million bond, at an interest rate of 5 per cent, when the provincial government is prepared to guarantee a bond issue at an interest rate of 2 per cent or 3 per cent? What benefit would there be to that at the local level?
[English]
Senator Grafstein: I believe there are four questions, which I will deal with separately.
First, with respect to the different approach of Quebec, there is a failsafe here, that no project will get federal funding or tax-exempt bonds unless the province approves the project. Nothing goes forward from the federal government. The city makes an application to the province. The province in turn either approves or not, and it allows the city to make an application to the bank. The Province of Quebec would have absolute control here, for many different reasons, as would every other province. There is not a question of impeding jurisdiction. The provincial government decides if they want to access this pool of tax exempt money.
Number two, in terms of the costs and the German approach and the French approach to gas tax, taxes are higher in Europe, in every category — higher gas taxes, municipal taxes, water taxes — and that is exactly my point. There is room for people to pay more for water services and for energy services, and they can do it in this fashion. I personally do not like the gas tax because I think that is irresponsible government. It means that the federal government raises money for gas tax and then just gives it to the city. That was the plan that some of us had originally when we were trying to wrestle with this plan, and I felt it was flawed. This is accountability and making people responsible for the taxes and the projects at the local level. It gives greater responsibility. Finally, it allows mayors to plan. Right now, we have been wrestling with the Gardener Expressway in Toronto, which is a mess. The mayor wants to rip it down or build it up or whatever. The easy way to deal with that is make it a toll road. We have a toll road on the 407 that is working fabulously well. It is one of the great models in the world. We tolled it and gave it to the private sector. I am not suggesting that. The city would be the beneficiary of the toll, as it is in New York. The City of New York benefits from the bridges and toll roads that are larger to recapitalize the renovation of those items.
Senator, I agree with all of your questions. They are important questions. We have to apply them here. With respect to costs, there will be more costs, but nothing is free. If we want to have modern cities, it will cost us more — no question. Today, the Mayor of Toronto has decided that he will impose, in addition to the regular tax, a $40 or $60 tax on every car in the city of Toronto, and I have no quarrel with that. I agree it is complex. Do not compare me to the Almighty; compare me to the alternatives.
Senator Hervieux-Payette: When I was talking about Quebec, if the federal government, in your proposal of $100 billion, loses $2.6 billion, I am saying of this amount, normally 25 per cent should be for Quebec. This is the provinces share in every program. If they refuse, they will ask for compensation. If the rest of the country wants to go along with this proposal, no problem, but it would not fly in my province. I have never heard, either lately or years ago, that municipal bonds were not issued because there were no buyers for them. They are selling well, and better now, even at 3 per cent interest, because people no longer trust the market. At 3 per cent, at least people know the money will still be there. We are not solving the problem of the availability of taxes. Actually, the money is available. The mayors have to have their projects approved in every province right now, because at the end of day, these bonds are secured by the province. You cannot add to the debt of the provinces. You would in fact jeopardize their ratings, whether they are double A or triple A or whatever.
You have not told us if the bonds would be guaranteed by the province or who would guarantee them. Now, municipal bonds are guaranteed by each province.
[Translation]
The Chair: I am sorry, but on that note from our vice-chair, I think we need to wrap up this discussion, at least for now.
[English]
I apologize to Senator Grafstein, but I have to end this interesting discussion. I know it is a beginning, not an end, in many ways. We thank you for being our first witness, as you should be, being the author of the bill. If you have further points to make, perhaps you can make them in written form or we can perhaps arrange for you to return.
I will now invite our next witnesses to the table.
[Translation]
The Chair: We are now ready to hear from the witnesses from the Department of Finance on Bill S-203.
[English]
Since the bill, if implemented, would provide that certain bond-related interest income would be exempt from federal taxation, not to mention whatever impact it might have on provincial revenue, I am sure we are all eager to here what the department has to say about this bill, particularly about the expected federal fiscal cost.
From the Department of Finance, we are pleased to welcome Mr. Baxter Williams, Director, Personal Income Tax Division, Tax Policy Branch; and Mr. Miodrag Jovanovic, Chief, Savings and Investment, Personal Income Tax Division, Tax Policy Branch.
Welcome, gentlemen. We appreciate your willingness to appear this afternoon.
Baxter Williams, Director, Personal Income Tax Division, Tax Policy Branch, Department of Finance Canada: Honourable senators, I will start with some opening remarks and some clarifications. There are a number of issues associated with tax-exempt municipal bonds, some of which pertain to the capacity of the Business Development Bank to administer a program like this. I would not be able to talk to those sorts of issues. I know it is a bad start to talk about what you cannot talk to, but representatives of Industry Canada would be better placed to speak to those issues.
Our remarks will mainly be around the effectiveness and potential market for tax-free municipal bonds. Although it may not be directly stated, the federal government and all provinces except Quebec have agreed to a common tax base, so when you introduce an exemption it would automatically apply in calculating taxes on provincial income as well as federal income.
Our rule of thumb for costs associated with an exemption or any measure that reduces revenues from the tax base is about a one third-two thirds breakdown. If the total federal-provincial cost is $1, the federal cost would be about 66 cents and the provincial cost 34 cents.
One issue in looking at a proposal like this is that the place where the bond is issued and the residence of the bond holder might be different. For example, a bond issued in Saskatchewan and recommended by the Saskatchewan government may be predominately acquired by bond holders in Ontario and Alberta. Because provincial tax is based on your residence, it would be those provinces that would bear the provincial revenue cost associated with the issuance of that bond. There is potential for a mismatch between the province where the bonds are issued and where the costs are borne for the bonds, at least at the provincial level.
As a general observation, it is important to distinguish between the ability of a tax exemption to lower the cost of issuing debt instruments versus its ability to improve access to financing. A tax exemption could potentially lower the cost of financing for municipalities but would only indirectly affect their access to financing, possibly, as markets grow in the future.
In the Canadian context, it is important to distinguish between the potential long-term cost for tax-free municipal bonds versus their potential uptake in the short term. It is difficult to say precisely how much tax exemption of this nature would cost because that would depend on the uptake of the bonds.
As a benchmark, we can look at other countries, such as the United States, which have had tax-exempt bonds in place for decades. Their current cost is about $35 billion annually. Since Canada is roughly one tenth the size of the States, you could expect that a program like this could eventually reach a cost of about $3.5 billion annually. We have no analytical method by which to arrive at a specific cost; we could only look at comparators and speculate on what the cost could be in a Canadian context over the long term.
It is clear, at least in the short term, that the costs would be substantially lower. There is only a very small percentage of the Canadian bond market where financing is provided by taxable investors. In fact, Statistics Canada data suggests that about 87 per cent of all bonds issued in Canada are held in tax-deferred retirement savings plans or other tax- exempt vehicles. Only 3 per cent of bonds were acquired by taxable individual investors. The remaining 10 per cent were acquired by taxable corporations.
A bond like this will find a very limited appeal relative to the size of the Canadian market. It is only over time, as the tax exemption would result in a growth in this market, that you could see the availability of finance increase through these instruments.
On that point, the recent introduction by the government of the tax-free savings account allows individuals to earn income tax free. We would expect the number of tax-exempt individual investors to shrink over the next years as people accumulate TFSA room and the program matures.
On the efficiency of a tax exemption, a dollar is spent whether through a reduction in taxes or through a direct expenditure by the government. In terms of the treasury, they are indistinguishable. The question is what is a more effective way of delivering support to municipalities. The key issue with something like a tax-exempt bond is that at least a portion of the value of that tax exemption is captured by the investor rather than by the municipality. Therefore, it will help them reduce their costs, but federal and provincial governments will only reduce their costs by a partial amount of the total costs.
The question is what leakage occurs when you look at a tax-exempt instrument. There we have to look at precedents as well. The two precedents we can turn to are the United States, where there are some estimates that suggest that 40 per cent of the value of the tax relief is captured by the investor on the individual side, and I think 25 per cent on the corporate side. I would have to check on that final statistic. That is one example. Essentially, for every dollar you pay out, 25 to 40 cents is lost, according to U.S. experience.
From a Canadian context, the one example we have is the Ontario opportunity bonds. You can get a sense of the tax leakage associated with them by looking at the rate that was offered on Ontario opportunity bonds versus the rate offered on comparable bonds.
I think the Ontario opportunity bonds were issued at a 4.25 per cent rate. Comparable bonds, the infrastructure renewal bonds, which had the same credit rating as the Ontario opportunity bonds, were issued at a 4.6 per cent rate. The municipalities were able to save about 35 basis points by using an instrument that was exempt from Ontario taxes.
However, what is an interesting calculation is to look at the after-tax return, in terms of at least provincial taxes, on the infrastructure renewal bonds. The after-tax return was 3.8 per cent on those.
What it meant is the total potential tax savings to the individual was about 80 basis points, but the municipalities were only able to capture about 35 basis points of that. That is another indication of the leakage that arises through using an indirect instrument such as a tax-exempt bond.
As a final observation, some of the U.S. literature has also raised other concerns associated with the bonds. I understand Senator Grafstein's proposal has the mechanisms that could potentially be used to address this to some extent.
However, there was a lot of pressure on municipalities in the States to underwrite projects which would not, strictly speaking, be considered public infrastructure, such as housing and sports stadiums, in order to take advantage of their ability to issue bonds on a tax-exempt basis. In terms of support for infrastructure, this is another potential area where you could see leakage in terms of the efficiency of this instrument.
I will ask my colleague, Mr. Jovanovic, if he has any further observations, but that concludes my comments.
Miodrag Jovanovic, Chief, Savings and Investment, Personal Income Tax Division, Tax Policy Branch, Department of Finance Canada: Just to clarify, we are talking about leakage and that we are seeing only a fraction of the potential tax savings captured by municipalities. One reason that may explain this is that when you issue these bonds, it may be difficult to rely only on the retail market, especially if that retail market, comprised of taxable individual investors, is relatively small. Therefore, you may have to tap into the institutional market to be able to place your $300 or $600 million of issuance.
In that sense, you have to raise the interest rate a bit to attract these investors at a margin. This may be a potential explanation why they are not able to fully capture the tax savings.
The Chair: Mr. Williams mentioned the necessity that would be required for the Business Development Bank of Canada to change its mandate. For the benefit of colleagues on the committee, I want to refer to a letter that we received from the Business Development Bank of Canada dated September 28, 2009, in which they declined to appear as a witness.
They stated that the bill proposes an important change to their mandate in which they were not consulted prior to this invitation, and also that the BDC does not currently have any in-house expertise on the matter of municipal bonds and therefore could not make a meaningful contribution to the debate. That is what they said in response to our invitation.
Senator Harb: When a bond is issued in a jurisdiction, can someone overseas buy that bond — for example, someone located in the United States or in Europe? If not, is that something that Senator Grafstein's bill should try and introduce as a suggested mechanism to generate more funds? You mentioned that the market is very limited; only 3 per cent of all of the bonds are purchased by corporations.
Mr. Williams: Or taxable Canadian investors. I do not think the issue is their ability to purchase their bonds. The difficulty is that their jurisdictions would not provide tax relief on them so there is no incentive for them to purchase the bonds, or at least the tax exemption does not provide them any incentive.
Senator Harb: If we have a non-resident entity that invests in Canada, they are taxed on their take-home, on a certain percentage of their profit.
If we were to provide what Senator Grafstein is talking about, a provision where we will give foreign markets an exemption, like we give residents of Canada exemptions, so we can generate extra money for municipalities so they can do the good things they want to do, would that not open a huge market for this particular initiative?
Mr. Williams: If you look at a rough breakdown of the Canadian bond market, in 2005 I think there was about $1.4 trillion worth of bonds outstanding; 87 per cent of those were held by tax-exempt entities. I do not think that would include what you are referring to. That would mainly, I would speculate, be pension funds and foreign investors.
Taxable corporations hold 10 per cent, and my understanding is that Senator Grafstein's proposal would apply to them. It is just that together with individual investors, they only make up a small portion of the bond market.
The Chair: Could I ask for my own clarification, is that breakdown a Canadian phenomenon? Is it atypical of the breakdown of bond purchasers in the United States or elsewhere?
Mr. Jovanovic: We did not make that comparison so I cannot really comment. As a general comment though, looking at the market in the United States, and maybe also because of the influence of the tax-exempt bond, maybe retail investors are a bit more prominent, but it would be just speculation. We did not look into that specifically.
[Translation]
Senator Massicotte: I have a highly technical, albeit straightforward question. You cited the case of Ontario which encountered major inefficiencies with its interest rate compared to the savings converted back to municipalities. Was that because the people investing in these Ontario bonds enjoyed a tax-exempt status? For instance, in the case of these Ontario bonds, were only taxable individuals or corporations investing in them, or could anyone buy them?
[English]
Mr. Williams: I do not think it was restricted. Perhaps Mr. Jovanovic could answer this.
[Translation]
Mr. Jovanovich: It is difficult to answer that question directly because we do not have that information. I do not know if the numbers have been broken down . I do not even know if Ontario is aware of the numbers. However, one of the reasons given by the Government of Ontario for switching from tax-exempt bonds to so-called Infrastructure Renewal Bonds, or IRBs, is that with IRBs, it can attract investment from institutions as well as from the retail savings sector, contrary to tax-exempt bonds which mainly attract small investors that do not enjoy a tax-exempt status.
Clearly then, there was some concern about being able to attract this fairly important market, which probably ties in with Senator Grafstein's point that in order for this scheme to work, a fairly large, liquid market is needed, something that we probably do not have in Canada at this level.
Senator Massicotte: If two or three types of investors are available, it is difficult to calculate the savings accurately because obviously, those who are not taxed are not ready to lower the interest rate. This is a somewhat arbitrary analysis, because we do not know who bought the bonds. I agree that perhaps the fundamental problem is the lack of market depth.
The Chair: If you have any further clarifications, please do not hesitate to send them to us.
Do senators have any further questions?
[English]
Senator Grafstein: I just have a short comment.
The Chair: A question, too, would be helpful.
Senator Grafstein: It is a comment and it responds to their questions. It is only two sentences.
I asked the Library of Parliament to give us an independent view of the question of the size of the marketplace, and they echoed your concern about tax-exempt bonds. Two-thirds of the market are held by tax-exempt investors. I agree with that. However, they went on to say the following, and I wonder if you would respond:
Pension plans, however, may be interested in municipal bonds, with or without a tax exemption, if the bonds would help them satisfy their risk management requirements, such as holding a diversified debt portfolio. Insofar as pension plans hold tax-exempt bonds without benefiting from tax exemptions, this would decrease the cost of the exemptions to the federal government.
Have you been able to talk to any pension funds about their attitudes towards tax-exempt bonds based on this particular proposition?
Mr. Williams: That is an interesting observation. We have not spoken to pension funds. Given the very healthy market for bonds in Canada, I guess a pension fund would go to a bond that, given any risk profile, that gives it the highest after-tax rate of return. Their being tax-exempt is the stated rate of return.
If the objective is to try to issue these bonds at a discount, why would non-taxable investors be interested in them at all?
Senator Massicotte: If that is the opinion expressed, would not the conclusion be that, if the non-taxable bond has a higher yield than a taxable one, it confirms to you it is not working at all? It means there is something very wrong when a non-taxable bond creates a bigger yield than a taxable one. It means there is no liquidity, no market. It means it is a failure.
Mr. Williams: I hope I did not give the impression that the Ontario Opportunity Bonds provided a higher face-value yield. It is just that their after-tax yield was higher.
The Chair: I wonder if I could use my privileges as chair just to ask one question at the end of this meeting. This is not a new idea, and I just wondered whether, from your perspective, things have changed since 2002? The then- Minister of Finance, John Manley, sent a letter to a member of the House of Commons, Ms. Judy Sgro, in response to her proposal or inquiry about tax-exempt municipal bonds.
It seems to me — correct me if I am wrong — that what he said is what you have said today, and what remains one of the difficulties to overcome. He writes as follows:
Most importantly, I believe that U.S. experience with those instruments has shown that the tax revenues foregone typically exceed, by a considerable margin, the interest cost savings to the issuers of the bonds. This is because the tax subsidy tends to be shared between municipalities (through access to funds at a below-market interest rate ) and the lenders (who receive the direct benefit of the tax preference). The diversion of part of the subsidy to lenders is inefficient; it raises the cost of such a subsidy to governments, while not delivering maximum benefits to issuers.
Mr. Williams: I guess I am heartened to learn that we are consistent with what we said before. I would say that captures our view on it.
The Chair: Of course, Senator Grafstein made the point that the money which would flow in would offset a lot of that. I cannot prevent myself from saying that the money that has flowed in from the change made to the treatment of shares donated to charities in which there was a considerable capital appreciation has been gigantic. You do not need to comment on this but I do not think that, when this proposal was initially raised, the Department of Finance was very much in favour of it.
However, I think it fair to say the provision has proved to be wildly successful and it has certainly brought in, to the charities at least, vast amounts of money. However, that is to deal an even hand to Senator Grafstein.
Are there any further questions or comments by senators? If not, I thank you both very much for your appearance. We appreciate it. I would like to advise senators that our meeting tomorrow will begin at 11:30 a.m., not 10:30 a.m.
In the meantime, this meeting is adjourned.
(The committee adjourned.)