VZCZCXRO2807
OO RUEHGA RUEHHA RUEHQU RUEHVC
DE RUEHOT #1322/01 1231717
ZNR UUUUU ZZH
O 031717Z MAY 06
FM AMEMBASSY OTTAWA
TO RUEHC/SECSTATE WASHDC IMMEDIATE 2320
INFO RUCPDOC/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RUCNCAN/ALL CANADIAN POSTS COLLECTIVE

UNCLAS SECTION 01 OF 03 OTTAWA 001322 
 
SIPDIS 
 
DEPT FOR WHA/CAN (BREESE AND HOLST) AND INR (SALCEDO) 
 
USDOC FOR 4310/MAC/ONA 
 
TREASURY FOR IMI (HOEK) 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PGOV CA
SUBJECT:  HARPER GOVERNMENT'S FIRST BUDGET DELIVERS TAX 
CUTS, SECURITY SPENDING, AND BLOC QUEBECOIS SUPPORT 
 
REF: (A) OTTAWA 513  (FINANCE MINISTER FLAHERTY) 
 
     (B) 05 OTTAWA 3399  (LIBERALS' FALL BUDGET) 
 
SUMMARY 
------- 
 
¶1. Tax cuts for households and businesses, breaks for 
families with children, and investments in defense and 
security were the key features of the Harper government's 
first budget, which was unveiled in Parliament on May 2 and 
is widely viewed as targeting middle class voters. 
Crucially for this minority government, the budget has 
support from an opposition party, the Bloc Quebecois, thanks 
to a companion document which recognizes the federal- 
provincial "fiscal imbalance" and sets out principles for 
addressing it in the longer term.  Together, the 
Conservatives and the Bloc have enough votes in Parliament 
to carry the day, despite NDP and Liberal vows to oppose the 
budget.  This budget was designed for popular appeal rather 
than economic principle, with a view to transforming the 
government's Parliamentary minority into a majority in the 
next election.  Budget documents are available online at 
www.fin.gc.ca. 
 
¶2. The government expects the budget to remain in modest 
surplus this year and next, but there is little room for 
error if the economy turns downward.  Economists, while 
generally positive, judged that the budget will mildly boost 
an economy which is already running at full capacity.  This 
means that tight restraint on other spending commitments 
will be needed in order to contain inflationary pressure and 
limit the need for interest rate hikes.  Even so, the 
appreciating Canadian dollar seems set to continue its climb 
above 90 U.S. cents.  This will deepen the rift between 
sectors which are prospering (energy, commodities) and those 
suffering (manufacturing, tourism) in the current mix of a 
climbing dollar, rising interest rates, high materials costs 
and a tight labor market.  End summary. 
 
 
TAX CUTS ALL ROUND 
------------------ 
 
¶3. In his speech to Parliament outlining the budget, Finance 
Minister James Flaherty sustained his themes of "focus" and 
delivering on commitments, while announcing a range of tax 
cuts that appeals to many constituencies.  Highlights are: 
 
-- Reducing the value-added-type Goods and Services Tax 
(GST) from 7 to 6 percent effective July 1. 
 
-- Reducing the general corporate tax rate from 21 to 19 
percent (this reduction was promised by the previous Liberal 
Party government a year ago but then withdrawn in order to 
obtain the New Democratic Party's support). 
 
-- Eliminating the corporate surtax in 2007-08. 
 
 
-- A tax credit of up to C$1000 on employment expenses. 
 
-- Eliminating income tax on scholarships and bursaries. 
 
-- Tax credits on textbook purchases, enrolment fees for 
children's sports and fitness programs, and monthly passes 
on public transit. 
 
¶4. These tax cuts were partly offset by an increase in the 
lowest personal income tax rate from 15 to 15.5 percent 
(this half-reverses a cut from 16 percent made by the 
Liberals last year). 
 
 
SPENDING PROMISES ADD UP TO BILLIONS 
------------------------------------ 
 
¶5. While it put the government's tax-cut and "frugality" 
messages foremost, Flaherty's budget speech also outlined a 
range of major spending promises, with little mention of the 
offsetting cuts which these imply.  Following are highlights 
on the spending side.  (While these figures are understood 
to represent new funding, such figures are often obscured by 
Qto represent new funding, such figures are often obscured by 
re-announcement and double-counting): 
 
 
OTTAWA 00001322  002 OF 003 
 
 
-- C$5.5 billion for infrastructure.  This potentially 
covers a wide range of items, but it explicitly includes 
urban public transit, border facilities, and highway 
approaches to the border. 
 
-- C$3.7 billion over two years for a child care allowance 
to families ($100/month for each child aged 6 or under). 
 
-- C$1.1 billion in the current fiscal year (which began 
April 1) for defense, and a cumulative C$5.3 billion over 
five years.  This does not include a specific commitment to 
fund the purchase of much-needed strategic or tactical 
airlift. 
 
-- C$1.5 billion in additional funding this year for farm 
support. 
 
-- C$1.1 billion for housing. 
 
-- C$400 million over three years to fund "worker 
adjustment" in the softwood lumber industry and to manage 
the consequences of the pine beetle infestation. 
 
-- C$307 million for immigration settlement. 
 
-- C$303 million over two years for border crossing programs 
for low-risk travelers. 
 
-- C$161 million for recruitment into the RCMP (the federal 
police service) and the ranks of federal prosecutors. 
 
 
-- C$101 million to begin the process of arming border 
guards. 
 
¶6. Observers commented that the government's statements and 
figures imply a need for offsetting cuts in spending which 
were not detailed in the budget.  Cuts are expected in at 
least three main areas: 
 
-- Public sector labor agreements (this will require a tough 
GOC stand in future negotiations). 
 
-- Programs for native communities (the budget provides much 
less funding than promised by the previous government under 
its so-called "Kelowna accords" with First Nations). 
 
-- The environment (the Harper government has distanced 
itself from the Kyoto Accord and the budget cuts funding to 
related programs in order to fund the tax credit for transit 
passes). 
 
 
REACTION/ANALYSIS 
----------------- 
 
¶7. Reaction to the budget has been generally positive, 
though with some targeted criticism from the left, 
particularly of the child care allowance (which some see as 
an abandonment of public daycare programs) and from 
aboriginal groups disappointed with the lack of commitment 
to follow through with the Kelowna accords.  Business 
reaction was enthusiastic. 
 
¶8. Economists and financial analysts were similarly 
positive, though with notes of caution.  Few were concerned 
about deficits, as GOC revenues have run well ahead of 
projections this year, and most seem confident that the 
Harper government will contain spending.  Even so, the 
budget's package of tax cuts and spending will be mildly 
stimulative.  This raises the likelihood that the central 
bank will need to offset its macroeconomic impact through 
monetary policy. 
 
¶9. The Bank of Canada, in a monetary policy report released 
just last week, judges that the economy is already at or 
above full capacity and that, despite a string of interest 
rate hikes over the past year, more monetary tightening is 
likely to be required to guard against inflation (currently 
around 2 percent).  That report, contrasting with more 
sanguine remarks from the U.S. Fed, has helped drive the 
already oil-fuelled Canadian dollar to highs not seen since 
the late 1970's. 
 
 
OTTAWA 00001322  003 OF 003 
 
 
¶10. The current mix of high energy costs, tight labor 
markets, rising interest rates and currency appreciation 
(not to mention global competition) has been especially 
painful for central Canada's manufacturing base, and for 
them, no relief is in sight. 
 
WILKINS