Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 9 - Evidence, October 1, 2009
OTTAWA, Thursday, October 1, 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 11:35 a.m. to give consideration to the bill.
Senator Michael A. Meighen (Chair) in the chair.
[English]
The Chair: Honourable senators, I know there are other members on their way who will arrive shortly. Perhaps, I can take this opportunity to go through the preliminaries.
We are continuing with the Standing Senate Committee on Banking, Trade and Commerce study on 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. It was introduced by our colleague in the Senate, Senator Grafstein — a former chair of this committee — on January 27.
According to the bill's summary, Bill S-203 would do the following:
[Translation]
This enactment amends the Business Development Bank of Canada Act to provide for income tax exemptions for municipal bonds to finance infrastructure projects.
We are pleased to welcome to the committee representatives of the Federation of Canadian Municipalities, the members of which include large cities, rural communities and 18 municipal, provincial and territorial associations. The FCM has some very clear opinions on the issue of our infrastructures, the magnitude of the deficit and the actions that are needed to address the problem.
[English]
I welcome our witnesses from the Federation of Canadian Municipalities, Mr. Mike Buda, Director of Policy and Research, and Mr. Adam Thompson, Policy Analyst. I note that your membership includes both rural municipalities and big cities. That was a subject that came up yesterday in terms of this proposed legislation and how it would affect each. Would the effects be similar or different? No doubt you can address that question.
I invite you to proceed Mr. Buda. I hope you will be amenable to questions.
Mike Buda, Director, Policy and Research, Federation of Canadian Municipalities: Absolutely. Thank you to the committee for inviting us to this session on Bill S-203.
I would like to start by saying that our president, Mayor Basil Stewart of Summerside, passes along his regrets. He would have liked to have been here. He is at the annual conference of the Saskatchewan Urban Municipalities Association in Saskatoon.
We welcome this opportunity because we are encouraged any time parliamentarians are thinking about and debating solutions to some of the problems that municipalities face. This hearing is proof that there is recognition in Ottawa that many of the challenges we face as a nation will only be addressed by working in partnership with municipal governments. We appreciate that.
Thank you for introducing the Federation of Canadian Municipalities. We represent 1,800 municipalities across the country that together encompasses almost 90 per cent of the population in Canada. It includes small, medium and large communities. It is every large- and medium-sized municipality in Canada and a large number of the smaller municipalities. A large number of very small municipalities are not members partially because of their size. They are simply too small to contribute meaningfully. Nevertheless, we represent everyone.
We have consulted a range of our members, mainly municipal finance officials and some provincially-run municipal finance entities. Mr. Thompson and I are not experts. We had the benefit of quick and informal, but instructive, consultations with some of our key members. They are the ones on the ground trying to figure out how to finance municipal infrastructure in municipalities.
We do not have a written submission. I apologize for that. However, we can certainly put some paper together following this meeting, if the committee would like.
The bill is clearly a solution to a public policy problem. I will start by reviewing some of the main problems that are facing municipalities, especially with financing municipal infrastructure, because it is always important to have a good grasp and understanding of the problem one is attempting to solve, before analyzing the efficacy of a solution.
It is no surprise that the primary challenge facing municipalities in financing their infrastructure is they do not have adequate resources to invest in the maintenance, renewal and expansion of that infrastructure. That has been the case from the late 1970s right through to the last couple of years. All orders of government — federal, provincial, territorial and municipal — have disinvested in municipal infrastructure. The result, over the last 20 years, has been an increase in the average age of infrastructure and a decrease in its life expectancy.
The result of these decades of neglect is an accumulated infrastructure deficit of $123 billion. That is just to renew our existing infrastructure. There is an estimated additional $115 billion needed to build new infrastructure to meet the coming demands due to population and economic growth.
It has taken 20 years to get to where we are. It will take no less time to solve this problem. There are no quick fixes. In considering this bill, it is important to consider what the roots of this problem are.
Our analysis is that the root of this problem is the fiscal crunch that municipalities are facing. Simply put, their roles and responsibilities are growing faster than their revenues. This is in part because of off-loading and cuts in public services by other orders of government. On the resource side, it is their reliance on a revenue stream — the property tax — which does not grow with the economy, unlike taxes available to federal and provincial governments.
Out of every dollar paid by the taxpayer, 92 cents goes to federal and provincial governments and 8 cents goes to municipalities. Because municipalities are required by law to balance their books every year, their only option is to shift the shortfall from their balance sheet and onto their infrastructure. The result is this deficit. We think this is the root cause of this challenge.
What are the options to address this problem? The first, obviously, is to consider the primary revenue means that municipalities have at their disposal, which is a property tax. Some 53 per cent of municipal revenue comes from property taxes. Anyone here who is a property taxpayer will probably agree that this is not the best tool to raise additional revenue. There are a number of reasons for that.
Over the past 20 years, property taxes have increased every year. Municipal revenues have had to increase every year — not as quickly as federal and provincial revenues have — even though federal and provincial tax rates have actually decreased every year. Almost every year, federal, provincial and territorial governments can reduce their tax rates, but their revenues continue to expand because those revenue sources grow with economic growth — income taxes, sales taxes and the rest. Property taxes are designed not to grow, but to remain stable. In times of economic downturn, that is advantageous but, in between those periods of downturn, they stay stable.
Having said that, most of you will agree that squeezing more revenue out of the property tax is politically not palatable and, from a public policy point of view, it is definitely not efficient. It is a regressive tax. It is a good tax when used properly, but the pressures on the property tax are much wider than it was originally designed for.
Raising that tax will be taxing economic growth. The classic example is that businesses that are not making a profit do not pay corporate or income taxes. Individuals who do not have an income do not have to pay income taxes. However, any homeowner or property owner has to pay a property tax. It is a very destructive tax from an economic point of view, but that does not mean it is a bad tax. We just have to look at how it is used. Municipalities have increased their relative reliance on property taxes by almost 20 per cent since 1988.
User fees are an important tool. There is no question, from an economic point of view, that we should be funding more infrastructure from user fees — things like tolls and higher utility rates. I do not think anyone can disagree with that, except for the population of Canada.
You will see this any time these issues are debated in various communities or provinces. The public is simply not ready for a wide scale use of user fees on what many consider core public services. It does not mean it is right; it just means it is what the public is saying now. We have moved a long way in the last 20 years and every year, municipalities and other governments are pushing the envelope. For instance, many municipalities, as a first step, move the cost of water and waste water services from the property tax bill to the utility bill. It still may not be funded at a full cost recovery, but it is getting people to think about the fact that, for certain public services, they should be paying a per- unit rate.
This is happening. Could it be ramped up quickly enough to address the infrastructure deficit? We do not think so. Every government that has tried to do so has been met with stiff public opposition. We should make more use of user fees. Municipalities are moving the bar forward slowly, but is it a solution? In the short term, we do not think it is a practical one.
Increased use of debt financing is an option for increasing municipal infrastructure investments. The data is difficult to collect but it indicates that municipalities are probably slightly underleveraged; that is to say, they should make greater use of debt financing. In cases of debt financing for investments that have a 20- to 50- or 100-year benefit period, some of those costs should be shifted to future generations. It is absolutely equitable. Intergenerational equity is an important concept.
There are a couple of reasons why some municipalities perhaps do not use as much debt financing as they should. First, in the 1980s, most municipalities, as well as other governments, got burned in the spike in interest rates and it has taken them 20 years to bring their debt ratios back to a comfortable level. Second, since the early 1990s, there has been a public distaste for public deficit financing and debt. As a result, I think of the very successful efforts by federal and provincial governments to reduce their own deficits. Municipal property taxpayers in some places do not take kindly to municipalities raising debt. It does not mean that municipalities should not make a better political argument, but it is an explanation for why debt financing is not as prevalent as it should be. Nevertheless, every year the use of debt financing increases. In many jurisdictions, municipalities are always fully leveraged. For instance, in Quebec, most municipalities are above their legislatively mandated maximum debt ratio. Therefore, there is surely some scope here for this option to provide a solution.
Another option that is discussed frequently is public-private partnerships. Public-private partnerships are a useful tool in some projects and some regions, but they are certainly not a cure-all. I will not get into the details here, but this is not a magic bullet for the problem of infrastructure financing. It is one of a number of tools.
Then we get to some of the options that we believe are the most credible and important. One is new fiscal tools being made available to municipalities so they can raise more of their own revenues. They are, after all, the primary owners of public infrastructure in Canada and the operators of municipal infrastructure. The most accountable way to finance that is to have the government who owns it actually raise those funds. This is definitely a core part of the solution. It is obviously one that the federal government has no jurisdiction over. This is a provincial and territorial issue. They are the ones that have legislative authority over municipal taxation tools.
Having said that — and we have seen these arguments played out in places like Ontario and other regions — shifting taxation tools to municipal governments is not going to be politically palatable unless tax room is made for them so the overall tax burden does not go up. Everyone would likely agree that the total tax burden on Canadians is probably where it should be, or is within reason. Simply giving the ability to raise new taxes to municipal governments without making that tax room will make it politically difficult for them to use those new tax tools. So, clearly, new fiscal tools are important, but they are not something the federal government has any control over.
Transfers from other orders of government are important. Transfers from other orders of government to municipalities fell through the 1980s and 1990s and right up to the early part of this decade. In the last seven or eight years, that trend has been completely reversed and it has been led by federal investments in municipal infrastructure. Many types of municipal infrastructure extend benefits to federal policy objectives, such as immigration. Most immigrants initially settle in larger cities and rely overwhelmingly on public transit. Without the provision of good public transit in our major metropolitan areas, this country likely would not be able to accept 225,000 immigrants per year at the current cost of that to the federal government. There would have to be additional federal support for subsidizing transportation costs. However, municipalities provide support for transit and, in so doing, benefiting the federal government. The federal government certainly has an interest in providing those funds and, clearly, transfers from other orders of government are part of the solution.
Those are some of the options. Our perspective is such that no matter what options are used, there need to be long- term plans and commitments by all orders of government to eliminate the deficit. It took 20 years to get here, and it will take 20 years to find our way out of it. A clear plan with milestones and set objectives is required so that accountability can be applied, as well as a commitment to investment by all orders of government over the long term. This cannot be solved in three to five years when investments are to be financed over a 20-year time frame or longer. The permanent Gas Tax Fund that the Government of Canada committed to in Budget 2007, originally introduced in Budget 2005, is likely the foundation of the federal contribution to this plan.
Before answering your questions, I want to spend a few minutes providing some analysis of how Bill S-203 stacks up against a problem that we have identified and the suite of available options in our view.
Certainly, tax-free bonds or some sort of taxation advantage to municipal infrastructure bonds will lower borrowing costs for municipalities. It will give retail investors a higher effective yield at a lower interest rate. To give people a sense of what lower interest rates mean, a reduction of a hundred basis points in interest rates on a ten-year bond results in a total cost savings to the municipality of 10 per cent. A $1-million bond issue over a 10-year period with a reduction of 100 basis points will save a municipality $100,000 in its total financing costs of both capital and interest. There are significant savings to be had. However, it is not clear what the interest cost differential would be. In May 2003, Ontario tried something similar. It seems that the savings in interest rates was between 50 and 75 basis points. Of course, that applied only to provincial taxation.
There is no question that this kind of initiative could encourage more municipalities to increase their use of debt, since the only way to benefit from this federal program will be to use these tools. Likely, it will increase public visibility and support for debt financing of infrastructure. Obviously, the marketing of these bonds can be unique and focused, but doing so will allow people to understand that the best way to finance long-term investments in infrastructure is through debt. Certainly, that is an important benefit.
In terms of the shortcomings, on the effectiveness side, we do not believe that this proposal is the most effective way of targeting the core problem, which is on the revenue side. The problem does not lie in paying interest or accessing debt by a municipality, but rather in repaying the principle. Reducing borrowing costs will help but, if the primary challenge to the municipalities is repaying the principle, then it is not the most effective way of addressing the problem. In fact, it is a tax expenditure because it will cost federal fiscal funds. It will necessarily substitute federal funding for direct investments in municipal infrastructure, such as the Gas Tax Fund or the Building Canada Fund, which will reduce the amount of capital available to municipalities to rebuild their infrastructure. Additionally, the cost savings that municipalities will be able to enjoy through this kind of program will not represent 100 per cent of the cost to federal fiscal funds. Some of the benefits of this federal tax expenditure will flow to municipalities and some will flow to the retail investors in these bonds. It will be a zero-sum game, and municipalities will be one of the beneficiaries, which is the purpose of the program, while the other beneficiary will be the retail investor, who may or may not be the objective of this type of policy initiative.
Given that it is a tax expenditure, it will be very difficult for the federal government to target certain regions or classes of infrastructure. For instance, if the federal government decides that one of its national objectives is to focus revenues and resources on improving waste water facilities in the country, then it will not be very easy to use this kind of tool for that work. From a practical point of view, it will be difficult for the federal government to gain much visibility in return for what could be a very significant tax expenditure.
On the efficiency side, from the municipal level, the analysis to date would suggest that the administration costs of this type of proposal could be very high, in fact so high as to counteract any of the benefits that might flow from it. Currently, many municipalities issue their debt either through a provincially-owned or province-wide authority. When they do that, they usually go through institutional bond issues, and institutional investors do not benefit from this type of measure because they are either tax-free entities or they pass the tax costs on to the end user. Thus, they will not benefit from the lower yield in any way. Even in cases where municipalities do not rely on province-wide finance authorities, they must rely on institutional bond issues, which are a more efficient way of doing it. Issuing retail bonds is more complex and is ten times the amount of work as issuing institutional bonds. It is simply a matter of expertise. Our banking industry is expert in selling bonds, and the municipalities are not experts. Banks have the marketing channels and the customers, whereas municipalities would have to build those bases. The anecdotal experience in Ontario's case in 2003 seems to be that the administrative costs might have eaten most, if not all, of the interest cost savings. That potential presents an efficiency concern.
In terms of efficiency at the provincial level, there are province-wide financing authorities. This kind of measure will compete with some of the very effective financing tools they have available now. It will also require legislative changes in many provinces, if not most, where municipalities are legislatively limited to how they can raise debt. There will be some administrative costs involved at that level.
Currently, Bill S-203 does not seem to apply to provincially controlled or provincially administered municipal financing entities, so there is a more direct concern. At the federal level, any changes to the tax system tend to be costly to administer and add complexity to an already complex system. One of the concerns held by the Department of Finance is that it will be difficult to estimate the cost of this, and it will make their budgeting decisions difficult in the future.
From an equity point of view, which brings me to your concerns, Mr. Chair, small municipalities do not have the capacity to manage complex debt instruments, which is why most regions have provincially owned or provincially administered finance authorities. Essentially, it is a way of capturing economies of scale in a province-wide entity and allowing smaller municipalities to amortize administration costs across the entire province or territory rather than having to bear all of the costs individually.
Small municipalities are not necessarily issuing debt alone so they will not be able to participate in this program. For instance, in Nova Scotia's case, where several years ago there was an attempt to encourage community bonds to be issued, only two municipalities took advantage of the program and both of them quickly withdrew. Only Halifax participated seriously, but it is a larger municipality.
This program will also force municipalities or provincial authorities to split their debt issues between taxable and tax-free. It will lower liquidity across the board and increase their total borrowing costs over the long term.
Finally, from an equity point of view, all taxpayers will pay for this subsidy, but only those who invest will recoup the benefit.
To conclude, we welcome the increase in attention to this debate. It demonstrates the understanding of the seriousness of this problem. In our view, a long-term plan to tackle this deficit is needed. One of the benefits of this type of proposal is that it would be a much more permanent, long-term and predictable financing mechanism. We are showing we need more of that. However, we think encouraging the greater use of debt financing will be the first part of the solution and it cannot replace direct investments, and there is certainly concern that it would.
If the objective of this bill is to increase a municipal use of debt, certainly the analysis we have done so far suggests it is not the most effective way of doing that. Existing cost-shared funding programs are likely doing more effectively what this program would do. It is forcing municipalities who want to take advantage of cost-shared federal infrastructure programs, such as the Building Canada Fund, to go out and raise the debt and they can make the case to their public that they need to do that in order to get matching funds from federal, provincial or territorial governments. However, unlike this type of proposal, those cost-sharing programs do not stipulate how municipalities raise the money. They make the funds available and it is up to municipalities as to how to come up with their share. It is accessible to all municipalities.
We certainly want to continue the dialogue and focus on infrastructure. It is not a sexy topic, so any time anyone talks about infrastructure, we are thrilled. We think the foundation for many of the solutions to the public policy challenges which we all face begin with good, sustainable and quality public infrastructure.
We welcome your questions.
The Chair: Thank you for a complete and even-handed analysis from your perspective.
For clarification, you said all municipalities were required by law to balance their budget. Has every province passed that? I know that law exists in the provinces I am familiar with, but has every province and territory has passed a similar law?
Mr. Buda: Yes. That is on the operating side. Obviously, municipalities are permitted to debt finance their capital budgets, but in every province and territory they are required to balance their operating budgets.
The Chair: Thank you for that clarification.
Senator Massicotte: Thank you for being with us today. Your resounding support for this bill is appreciated. Having said that, I would not mind having a debate about the best form of raising money for municipalities, so that we can be better educated.
As a starting point, every level of government wants more money if someone else can source it, because they do not want that responsibility with their citizens. There is no question everyone wants more money and would love more from the provincial and federal governments.
Probably the first existing tool is tax. Many years ago, I did a special study for the City of Montreal relative to its downtown area. All cities think they are bearing too high a burden of taxes for their downtowns given all the people who working there, but that is offset by the fact there are a lot of high-rises and so on. I was involved in this debate. They all say no, but if you look at property taxes in Canada compared to many jurisdictions around the world, they very reasonable and, one could argue, there is some slack there to increase it further.
You will make the valid argument that it is, perhaps, not the most equitable manner to raise money because it represents ability to pay. If you have more real estate, then you have a greater ability to pay, but it is certainly less equitable in measurement of income or income tax, et cetera.
If you look at the world, you can see there is a bit of movement there. If it is so important for them to improve their infrastructure, why do they not stand up at the annual budget meeting and say, ``My fellow citizens, I want to increase taxes because I want to build an arena or something.'' However, they do not do that because they do not want to assume the responsibility. If it has that much merit, why do they not convince their cities and their populations of it?
You made the argument that the evaluations are constant. I beg to differ. If you look at the past 30 or 40 years, real estate values have gone up higher than inflation, which is why a lot of people invest in it. They have gone up dramatically. Additionally, you can always change the mill rate. Look at what is happening in the United States today: For example, in Florida, the real estate assessment has gone down by 30 to 40 per cent. The mill rate went up. In fact, the tax bills were changed so that in terms of constant dollars one did not see the values go down, but just the mill rate going up.
Why do this so quickly? I know there are better tools, but why not say, ``Mr. Municipality, do your job. Sell the need to your population and, if you cannot sell it, maybe it has no merits''?
Mr. Buda: Absolutely. First, every year most municipalities in this country make that exact case and every year property taxes increase. In terms of the relationship between the mill rate and tax increases, in most regions in this country, municipalities adjust the mill rate so that their revenues remain stable. If the council decides there will be an increase, the increase is applied as compared to the changes in the assessment.
If the average assessment in this city, for instance, goes up 10 per cent, the mill rate will be adjusted downwards 10 per cent, on average. If the local government decides that there will be a zero per cent tax increase, which, as you know, was the commitment of the mayor of this city, the assessment goes up the same as the average 10 per cent, then taxes will not change as compared to last year. If taxes go up 20 per cent, one will pay a 10 per cent tax increase. If the assessment stays stable — 10 per cent lower than the average increase in assessment — the tax rate will go down.
The tax burden shifts from those houses whose assessments have gone down that year to those which have gone up. Over all, mill rates are adjusted to maintain a level playing field. You are right: Some municipalities have used rapid increases or rises in assessment to disguise increases in revenue. Most municipalities in Canada do not follow that practice, but some do. Most do not because they know what happens when assessments go down. It is a lot more difficult to save your revenue.
That gets back to the purpose of property tax. The purpose of property tax is to pay for services which householders consume. It is not designed to raise money according to ability to pay. Progressive taxes do that because they are designed to provide services to citizens who could not otherwise afford those services. People on social assistance or on EI likely do not have the taxable income to pay for the benefits they are accruing for their services. That is why we have progressive taxation, to provide a social safety net.
Property taxes are designed to provide services for property. At the time property taxes were developed, it was seen as a more efficient way of collecting revenues for services delivered to individual properties. Although it technically would have been possible to levy a separate charge for fire and police — and that is how things originally developed — in the 1800s and in the early part of the last century, the early days of the creations of local government around the world, it was seen as a more administratively-efficient way to bundle all those local property-based services into a property tax.
Around the world, people have used different assessment systems. Here we base it primarily on value. In other countries, they base it on the size of the lot or the number of bedroom, bathrooms and all sorts of mechanisms. The end result is that one is trying to fund services to property.
You are right in that if the property tax is used just to fund services to property, then it would be a lot easier to make a case to increase it. The problem in Canada is that now municipalities are delivering services to a lot more than just property. They are delivering a wide range of redistributive services, for instance building or maintaining social housing and immigrant settlement. They are delivering a fairly wide range of policing responsibilities that the federal or provincial governments are supposed to be delivering, whether it be port or border policing or major international crime investigations.
There are a number of services that have been offloaded onto the municipal property taxpayer, either explicitly or implicitly, when other orders of government cut funding to public services. Then, frankly, the problems end up at the doorstep of the municipal government. Homelessness is an example of that. It is difficult for a local politician to step over a homeless person on the steps of city hall and ignore citizens who are outraged by it. It does not mean they should because, obviously, they should not be delivering that type of service, but they have because the demand is there.
The reality is that property tax is servicing all these other things that it was not designed to do. FCM's first prescription for this problem is to upload those responsibilities and for other orders of government to actually deliver the services they are either constitutionally supposed to deliver or who have superior tax tools. If that were to happen, you are right: A property tax would likely be sufficient. Will that happen? I do not think so. It is very complex to unravel some of these responsibilities and, more importantly, very difficult politically.
That is all to say that the property tax is a good tool. It could be raised, but I think it would be very difficult for mayors and provincial and federal politicians to make the case that it should be raised. That is why politics is the art of the possible and not necessarily the most rational. Some of what we are suggesting is what we see as more possible, but it is certainly not the most rational.
Senator Massicotte: So, in conclusion, you think it is easier for federal politicians to raise taxes than for municipal politicians?
Mr. Buda: Rightly or wrongly, that is the case now. The flip side of that is that it is easier for federal and provincial governments to download responsibilities to municipal governments and offload those responsibilities, because municipal governments can do nothing to stop that. So it goes both ways.
Senator Harb: Thank you, Mr. Buda and Mr. Thompson.
Have you had a chance to look at the American experience? In his presentation yesterday, Senator Grafstein said that there are a number of jurisdictions in the United States that use these bonds successfully to raise money. Do you have any information regarding that experience that you can share with us?
Mr. Buda: That is one of the things we wanted to spend some time thinking about. We asked the group of municipal finance officials whom we consulted on these issues and we simply did not have time to get to it in depth.
The comments I have received, and the reports I have read, suggest that in some states it has proven to be an effective way, especially for smaller municipalities, to raise money. However, the municipal finance system is quite different there. In many states, state-wide municipal finance authorities do not exist, for many reasons. It is in part because many municipalities in the States have home rule, that is, they are sovereign entities in themselves and it is difficult for state bodies to exert that much control over them. In other words, these types of small retail bonds exist because they are unable to develop mechanisms to access cheaper, more efficient institutional bond offerings.
The other thing is that the municipal government system in the United States is much more disaggregated than in Canada. There are a large number of extremely small municipalities. What we think of as the city of Seattle is actually 234 municipalities, and that is a city the size of Toronto or Montreal. In some cases, they had to develop these mechanisms because of their municipal government structure, not because it was the most efficient or effective. It was because, given the context, it was the best way of doing it.
In most regions in Canada, there exist province-wide finance authorities, and we do not have the same municipal governance system they have in the United States.
Senator Harb: You said some positive things and some negative things about the proposal. If this proposal becomes a reality, municipalities would have the ability to make submissions, get the approval of the provinces and so on, and they would have the tools to raise money. In your experience, do you think some municipalities will take advantage of such a proposal? What type of municipality would be interested in this type of proposal?
Mr. Buda: The Nova Scotia experience is instructive. The Province of Nova Scotia and the finance authority there encouraged small municipalities to issue community bonds for local infrastructure, and the take-up was virtually nil. Right away there is a concern that, if this proposal is designed to help small municipalities access debt, it likely will not do so, and that is because of the complexity of administration of debt instruments and because they often have access to other debt instruments, such as through provincial borrowing authorities.
The group we consulted said that some people would certainly use it, but they probably would not access it as frequently as perhaps the designers of this bill would like because of the administration costs. Some people said they would use it when it makes sense, but it will not make sense in every case.
I have worked for a municipality and, in my experience, the less you do out of habit the less you continue to do it. If people are not going to use the tool regularly, it will likely be used less and less regularly because municipalities will not build up the expertise to manage this kind of debt issue.
On balance, it would absolutely be a useful tool to add to the arsenal to fight the infrastructure deficit, with a couple caveats. First, any tax expenditure is an actual expenditure to the federal fisc and, all things being equal, the federal government would likely choose to reduce its investments in direct funding programs. Everyone whom I consulted said they preferred direct funding over this type of less direct funding so that is an important caveat.
Second, the costs of administering this type of program may outweigh the benefits. If they do not, it is sufficiently inefficient that the cost benefit might not be as favourable as one would think.
Senator Harb: You mentioned that, if this were to become reality, one benefit would be to reduce borrowing costs to municipalities. I suspect that some people will take advantage of this bond because, even though the interest rate will probably be a little lower than it could be, the income will not be taxable.
Yesterday officials of the Department of Finance appeared before us and said that 90 per cent of bonds issued in Canada are taken up by entities that do not pay tax anyway. That is quite revealing. They said that 7 per cent fell into other categories, which left 3 per cent of the whole pie on the table for retail investors and the average citizen. That was an eye-opener for many of us.
I asked the Finance officials whether this might be made available strictly to investors from outside of Canada who otherwise may not find that there is enough on the table for them to take. I also asked about gearing this toward pay- per-use. Senator Grafstein used Highway 407 as an example. If one were to identify a megaproject with user fees that was available strictly to those who otherwise may not come to the table, would that work? This is outside of this box, but would that be an attractive mechanism?
Mr. Buda: Yes, there is a range of alternative financing mechanisms, public-private partnerships by another name, that exist that could increase the pool of financing available to municipalities, but in the end, no matter how you finance a project, someone has to pay the interest and the principal.
In a public-private partnership, there are a number of ways that theoretically costs can be reduced. They include supposedly more efficient management of these types of projects by private entities, which undoubtedly exists; the transferring of risk from the public entity to the private entity; and, obviously, the recouping of user fees.
As I said in my presentation, user fees certainly should be and need to be increased, but as the experience of Highway 407 demonstrated, they can be increased for some types of infrastructure but, as public debate in almost every region of this country has shown, increasing user fees for basic services like water is difficult publicly. That does not mean that we should not continue to try, but it will not be a quick solution.
To answer your question, alternative financing mechanisms such as the Department of Finance officials suggested are real and useful to explore. Of course, that bears no resemblance at all to Bill S-203. It is much more complex. In fact, many jurisdictions, including Ontario, are already pursuing those types of mechanisms. Indeed, the new P3 Canada office is doing exactly that kind of work, and they do not require changes to taxation law to do so.
The Chair: Before I turn to Senator Gerstein, on a point of clarification, Mr. Buda, you referred to the Nova Scotia experience and I think you said those community bonds had little take-up. Were they guaranteed by the province? They would have to be, would they not?
Adam Thompson, Policy Analyst, Federation of Canadian Municipalities: Yes, they were. They would have been issued through the municipal finance authority there, which already has provincial backing.
Mr. Buda: In all cases municipal bonds generally have interest rates almost as competitive as those the provinces offer, which are only a tiny bit below what the federal government offers. In all cases municipal bonds are backed by a direct lien on property tax payments. It is a pretty fail-safe investment and that is, in fact, why in the darkest days of the credit crisis last year, it was municipal bonds and provincial bonds that became the darlings of the bond industry. It was a fail-safe investment. Everything else was going to pot and you could at least invest in a bridge.
Senator Gerstein: Thank you, Mr. Buda, for an excellent and comprehensive presentation today. I would be interested in hearing a little more. What is the size of the municipal bond market in Canada today? Is it a robust market or is it very limited? I am not looking for you to get particular, but is it small, medium or large? I would like to understand a little further as to what restrictions exist as to a municipality's being able to issue bonds from a legal perspective?
Mr. Buda: As to your first question, we do not have the specific numbers here.
Senator Gerstein: Would you characterize it as small, medium or large?
Mr. Buda: The 3 per cent number is the one number I was able to get. That means that 3 per cent of the total bond market is retail.
A large percentage of the public bond market, that is, bonds that are issued by governments, are actually municipal bonds. Therefore, all that is to say the size of the municipal bond market for municipalities is tiny. For instance, the Municipal Finance Authority of British Columbia, which is not provincially owned but is actually owned by the municipalities of British Columbia, does not issue a single retail bond. It does not issue retail bonds because they say it costs far more money and it is able to sell all its bonds in the institutional market.
In most cases that we were able to find in our quick consultations that was the case. It is unusual for municipalities to issue retail bonds. If the institutional market dried up, they would have no recourse. However, as long as the institutional market offers competitive rates and some liquidity, which it has and seems to continue to do because, as I said, even in the darkest days of the credit crisis, municipalities had no trouble selling their debt issues, people are unlikely to resort to a bond market that is more costly. It is not a big surprise that if you have 1,000 customers it is more expensive to sell to them than if you only have five, and that is the reality for municipalities.
In terms of what kind of authorities municipalities have, it varies tremendously by province. That will be one of the challenges for the federal government implementing this kind of bill. You will have to have different regulations enacted specific to each province. For instance, in British Columbia, all municipalities are required, over a certain debt issuing size, to finance through the Municipal Finance Authority of B.C. I talked to someone from B.C. and I asked if they had ever chosen to bypass FMA by keeping debt issues below the minimum, and was told no, there would be no reason to. MFA has the best rates in Canada, actually better than the province in that case. There are zero administrative costs, which are paid as part of a very small mark-up. There would be no reason to hire at least two people in a municipality to manage their own debt issue. You can forget that.
Other provinces are required to go through the province. In the province of Quebec, municipalities are required to get authority through the province. In most cases, although technically municipalities have the authority to do so, they simply just choose not to because it is not the most efficient way for them. It does not mean they cannot.
Senator Hervieux-Payette: I have one question, which I asked yesterday of the Department of Finance in making a comparison with Europe where they pay more for their gasoline. What would be needed in terms of an increase? Would the municipality be happy if we gave them a higher percentage of the gas tax than we presently give them?
Mr. Buda: That is actually what FCM has for a number of years been calling for, all three orders of government to commit to a long-term plan to eliminate the infrastructure deficit.
Senator Hervieux-Payette: That would be for over 20 years.
Mr. Buda: Yes, over 20 years. We said something that actually surprised the House of Commons Finance Committee in 2006, and that was that we cannot actually say how much it is because there has not been a comprehensive survey of the size, scope and nature of the municipal infrastructure deficit in Canada. It is really a very complex exercise.
For instance, in the city of Montreal they have sewer pipes that are over 150 years old and are made of wood. They barely know that they exist. Therefore, it is not an easy thing to inventory your assets and decide on how old they are and when they need to be replaced, and it is not something municipal governments on their own can undertake.
The first step in solving a problem is deciding how big the problem is. FCM has done some rough estimates and that is where the $123-billion figure comes from, but it is not specific or detailed enough. We first need to do an inventory and, in fact, we understand Infrastructure Canada and Statistics Canada are working on such a survey. We are tremendously encouraged by that.
Having said all that, what is an approximate cost? Well, if the total infrastructure deficit is about $123 billion, simply divide that by 20 years. Obviously the federal government is not 100 per cent responsible for paying for it.
However, we say the gas tax is the foundation for the federal government's contribution. We think it needs an index so that it grows with the economy and population. It needs to be maintained and it needs to grow with the economy. Also, there will need to be targeted funding programs that are directed at those aspects of the infrastructure deficit identified through a more comprehensive survey that will need additional investments.
Is it an extra $2 billion or $5 billion? We cannot say, but it is certainly not 10 times more and it is not 100 times more. It is probably not much more than we are spending now. The federal government is investing approximately $2 billion to $5 billion a year on average over the last several years on municipal infrastructure, and that is not including the stimulus fund, which will obviously be a spike, an aberration, in federal investments.
The Chair: What is your view on the continuing challenge of accountability? There are critics who say, well, if you hand money over to a municipality, how do you ensure they spend it for the purposes you originally had in mind?
Mr. Buda: Absolutely. I have two comments on that. One is that existing federal infrastructure programs, such as the gas tax and the Building Canada Fund, have robust reporting and accountability mechanisms that Treasury Board has approved, and that include public reporting of the expenditure of those funds.
Related to that is municipal governments are by far and away the most transparent order of government in Canada. All decisions have to be made in public. They are required to report on their finances every year and answer to them in a public forum, and that includes any federal contributions towards their expenditures. The accountability mechanisms are already fairly strong.
The last thing is that in almost any public opinion poll which asks which order of government Canadians most trust; municipal governments are always at the top and always quite a bit above the federal government. One could probably flip the question on its head and ask how we can be sure there are accountability mechanisms for the federal government for the proper allocation of federal funds.
All kidding aside, you are right. Any time one order of government raises taxes and another order of government is responsible for spending it, there is always the challenge of accountability and that is why we need to continue to look at the full suite of solutions to the problems of municipal finance.
The Chair: Well said.
Thank you very much, Mr. Buda and Mr. Thompson. Before this session started Mr. Buda said he was going to throw all the difficult questions to Mr. Thompson. I am not sure what that says about the degree of difficulty of our questions. Mr. Thompson had an easy time of it, but we are glad to see you. We appreciate what Senator Gerstein said about the comprehensiveness of your presentation.
(The committee adjourned.)