POLICY OPTIONS: Mr. Flaherty, thank you for doing this. The budget, from fiscal imbalance to fiscal balance, and the $39-billion transfer story. It must be nice to live in a time of plenty.

JIM FLAHERTY: It is. That figure is over seven years, and it was met with general acceptance, a bit of a disap- pointment in a couple of places, but I see even since the budget that there is some increasing acceptance of what we did. So that’s good, and I think over time, two or three years from now, there will be very little discussion about the formula, because it will produce good revenues for the receiving provinces, and the transfer payments having moved to a per capita system for most of the grants will be accepted by those provinces that were very concerned about so-called double equalization.

PO: The fiscal imbalance is a line ”” a line a bit like Kyoto targets, and pere- stroika, and glasnost ”” that is a mantra, but I am not sure that people understand what it is about. Are you one of the few people in the country who understand the fiscal imbalance, and the contents of the equalization formula?

JIM FLAHERTY: I am not sure how well I understood it as a provincial minis- ter, but I understand it now as federal finance minister, and there were a few questions that had to be addressed. One was, was it going to be a principles-based formula, and inevitably if that were so, then there would be provinces that would be unhappy, because they were more inclined toward an ad hoc arrange- ment. And secondly, would it be a 10- province standard and would it be capped? And thirdly, would we move basically to per capita grants? And those things together cost money. But if we resolved those issues, which we have, then it is going to be difficult, I think, for any province to credibly attack the equal- ization and the transfers in the future.

PO: How much of this is about sta- bility and predictability for long-term fis- cal frameworks and planning horizons?

JIM FLAHERTY: A lot of it, a good part of it. It gives finance ministers seven years to plan ahead, and you need to do that. I mean, one of the greatest needs we have in Canada is our infrastructure needs, and that’s long-term planning.

PO: A week before the election $2.3 billion of this went to Quebec, $1.6 billion in transfer payments in old equalization money, if you can call it that, and transfers on the envi- ronment and higher education, and $700 million under new equalization. Six days before the election, Mr. Charest gave the new equalization money back to the Quebec taxpayers, or said he would, in a tax cut, that probably resulted in some blowback, understandably, in English-speaking Canada. Without getting into the details of the Quebec campaign, do you have a view of that, of this kind of equalization money being used for fiscal frameworks, as opposed to comparable services?

JIM FLAHERTY: Well, on a constitu- tional basis I don’t have any problem with it, because that section of the Constitution provides that all people in all regions are entitled to reasonably comparable social services ”” I am paraphrasing here ”” and reasonably com- parable levels of taxation. So if the receiving province wants to take some of the funds and use it to reduce their taxes, where taxes are higher than the average, which they are in Quebec, then that is legitimate from a constitutional perspective. From a political per- spective it looks like it didn’t help Mr. Charest; it may have in fact harmed his party and it was not helpful in the rest of the country, certainly from com- ments that were made across Canada.

PO: Seems it was almost badly packaged by Quebec, by the Quebec Liberals, if I can put it that way. Where was the other $1.6 billion that is going for the environment and post-secondary education and health services and so forth ”” the focus was purely on the $700 million, which was less than 25 percent of the envelope.

JIM FLAHERTY: Just as a gen- eral comment, and I have been through a few elections, I am not a fan of promises, fiscal commitments being made during the course of the campaign.

PO: It didn’t work big time for David Peterson in 1990, did it?

JIM FLAHERTY: No, no, it is when governments do that during the course of the campaign that it does not enhance their position, I think.

PO: What about this fiscal balance/imbalance as part of a larger debate of conceptual fiscal federal- ism, which is to say, fiscal federalism in the context of open federalism as Mr. Harper calls it, or classical federalism, or BNA federalism? Which is to say the Canadian Constitution that you and I learned about in high school, and the British North America Act, and the division of powers in sections 91 and 92, and Ottawa having peace, order and good government in section 91, and the provinces doing what the provinces do in section 92.

JIM FLAHERTY: I think the new arrangement advances that cause and intentionally so. As you know, the Prime Minister has also talked repeat- edly about respecting the provincial jurisdictions and their responsibilities under the Constitution, the BNA Act, and restricting federal participation in areas of clear provincial jurisdiction. And I agree with that: we have enough to do here, particularly if we do what the federal government is supposed to do, and do it well, and fund it properly. Like our obligations with respect to national defence and national securi- ty, which are very substantial, and our obligations with respect to the infrastructure are huge. And if we get those things right from a federal point of view then that is good government for Canadians, and we restrain the federal government from dabbling in areas of provincial jurisdiction: for example, in university tuition and that kind of thing, which are clearly none of our business.

PO: As opposed to funding of Canada Research Chairs, and Canada Scholarships and so forth, which is about our competitive position in the world.

JIM FLAHERTY: Yes, and actually I think that is sort of a handsome marriage, that we can help the universities and the colleges on the research innovation side, and then let the provincial governments take care of the day-to-day operations and funding of the uni- versities and colleges.

PO: In the budget papers there was some discussion or some reference to limits to the federal spending power. This would always be, if you were the head of ”œImperial Finance,” that would be a pretty touchy topic over there with some of the encrusted officials.

JIM FLAHERTY: Well, I have noted a tendency toward expansionism in Ottawa that is really quite remarkable. We really have to be careful, we have to be good stewards together to make sure that we don’t empire-build here.

PO: Just anecdotally, I was in the room in 1987 at the Meech Lake meeting, in the officials’ room, when Richard Hatfield came in at 3:00 in the morning of the Langevin lock- up and said, ”œWe are down to one word.” Derek Burney said, ”œWhat’s that?” And he said, ”œThe word ”˜the’.” As in what? The federal spending power. Quebec didn’t want the word ”œthe” to be included in federal spending power. That’s how sensitive the topic was. Is this the kind of debate that would be envisaged if there was to be a First Ministers’ Conference, as between Ottawa and the provinces, on where the federal spending power was on the table?

JIM FLAHERTY: You know, our government hasn’t followed that style either; we have had, I think, more per- sistent regular communication with our provincial colleagues.

PO: Well, Roger Gibbins in an article in our magazine last month referred to the division of powers essentially being swamped by the fed- eral spending power. How do you reconcile the constitutional framework of the 19th century, assuming that the Fathers of Confederation knew what they were doing, with some of the real- ities of the 21st century ”” the needs of cities, our competitive position in the world, things like that? Higher education, or the environment, which is a mixed jurisdiction?

JIM FLAHERTY: Well, I was happy with this budget, where I saw Roger Martin for example, of the Institute for Competitiveness and Productivity in Ontario ”” I know Roger from my time there, and I was the minister responsible for that institute at one time. When he analyzed it, he expressed that almost two-thirds of the spending went toward productivity issues, 64 cents on the dollar, so I am glad he recognized that, quite frankly, and it’s some exterior validation for what we are trying to do. I do think that is the role of the federal government, to have the big picture, the macro picture of the economic federation in mind, and strengthening the economy overall. And I have had those discussions at length with the provincial finance ministers, and both times that we have met we have spent the mornings on that subject, not about fiscal balance, or fiscal imbalance, or other issues between the provinces and the federal government. If we continue to pay down debt, if we continue to reduce taxes, if we focus on our priorities and fund them well ”” the Armed Forces, for example, and the infrastructure, just those two alone, I mean, we are talking over the next several years $50- 60 billion. These are huge numbers to take care of our own responsibilities, and there isn’t going to be a lot of money left ”” barring some incredible economic expansion ”” to meddle in other people’s areas of responsibility.

PO: Now, you sort of declared the fiscal imbalance to be probably solved on opening day, if I can call it that. The budget rolled out on March 19, and of course the sun hadn’t set, not even over Saint John’s, Newfoundland, when Danny Williams was basically going off the dial claiming betrayal. But, realistically speaking, how can a province, a ”œhave-not” province, have a fiscal capacity that exceeds that of a have province like Ontario?

JIM FLAHERTY: Danny Williams’s argument doesn’t make any sense. He and I have had that discussion, and I like him personally, but the idea that the fiscal capacity of the province of Newfoundland and Labrador could continue to expand and nevertheless continue to receive more and more money is nonsensical. And I didn’t say that the resolution of the problem would result in everyone standing up and cheering. The provinces cannot agree, and so we knew that Newfoundland and Labrador, certainly, probably Saskatchewan and some questions in Nova Scotia would arise. I was not optimistic about getting anywhere, quite frankly, with Premier Williams because he is not rational in his analysis.

And Nova Scotia was a bit rocky at first, but we had further discussions with them. They didn’t have much time, because their budget was on Friday, and mine was on Monday, and they had a budget shortfall, so there was a bit of anxiety, more than a bit. But we had some good discussions last week, and they have elected to go to a new equalization formula for the time being, but we gave them the option of going back to the Offshore Accord in the future, next year if they want, and I think over time there will be recognition in Nova Scotia that this is actually the better of two equalization plans.

PO: I have the sense that Nova Scotia got pushed into a reactive mode, because Williams went ballistic.

JIM FLAHERTY: Yes, I think there was some of that, and their situations are comparable, but not the same. Saskatchewan and Newfoundland and Labrador both have come to grips with the delightful reality, and that is that they are both moving in the direction of becoming have provinces, particularly Saskatchewan. Saskatchewan, if things go according to plan, will not receive equalization in 2008-09, and they should celebrate that. As I said to their minister, that should be the goal of all Canadian jurisdictions, that even- tually equalization will not be required.

PO: How much of that sort of ”œget- ting your self caught up in the thick of it,” if I could put it that way, is a result of the open bar policy that was run by Mr. Martin, with the one-off deals he was making with the provinces?

JIM FLAHERTY: Yes, and during the course of the discussions this past year or so, we had provinces propose, ”œSure, why don’t you have this long-term arrangement, but for us, let’s have this deal on the side,” which is what hap- pened in the past, of course, and that is precisely what we refuse to do, and we will not do going forward.

PO: Predictably some of the stakeholders were on your case, including some of your ”œfriends,” the Conservative government’s friends, the Canadian Taxpayers Federation, the big business crowd, Andrew Coyne.

JIM FLAHERTY: He used to like me. Not any more. Well, the small business folks were happy because of the paper on issues, in that capital gains changed from $500,000 to $750,000 which was the number one request of the Canadian Federation of Independent Business. For some of the big business community there was a bit of a negative reaction in the sense of there was noth- ing in it for them, but we already brought in two reductions in the corpo- rate tax rate which are coming and will happen over the course of the next cou- ple of fiscal years. And quite frankly, business is doing rather well, the profit levels are high, and as a result our tax revenues are good, on the corporate side and on the personal income tax side.

PO: We come to the tax cut aspect, or the tax credit aspect of the budget. Some would call it a Santa Claus budg- et; perhaps it is more like a Tim Horton’s budget, that it plays well in the suburbs for people with families with kids in school under the age of 18. Income splitting for seniors it seems to be aimed at 905 land and 450, and 604, people who live in the suburbs and go to Canadian Tire on Saturday mornings.

JIM FLAHERTY: Well, that is where the need is. I mean, a lot of the things that we do in life are based on our own experiences, but one hopes to be analytical as well. You know, I have a lot of friends in downtown Toronto. I practised law in downtown Toronto for more than 25 years and a lot of them have done real well. And they actually don’t really need any help from the government, and they are good Canadians and they pay a lot of tax, and I appreciate it, but they don’t need any help. I have lived in Whitby for about 20 years and I do see people struggling with their families, with bills, and higher electricity costs, and so on. They are middle-class people in the sense that they have enough money to live on, but you get two people working, one mortgage, or two mortgages, two cars, at least one car loan, ballet lessons, hockey lessons, you know, car repairs. Usually one of them or both of them may be salaried, not getting any particular write-offs, and we have high taxes in this country. They have trouble paying all of their bills, and the focus of the budget is entirely intentionally on families, three million families in Canada.

The focus last year on children under the age of six was also entirely intentional, both very expensive pro- grams, and both aimed at families with children in Canada.

PO: You have been in this job now for about 16 months. Do you have a sense why Ottawa, and particularly Finance, has difficulty building pre- dictability into surplus forecasting? They keep missing the number on the upside, which is a nice position to be in, but…

JIM FLAHERTY: I eliminated the so-called…what did they call it, it was a cushion…

PO: A contingency fund?

JIM FLAHERTY: They called it something else, but I got rid of it anyway, with some resistance, I might say.

But so anyway we got rid of that, and still we ended up with a big surplus this year. The one legitimate challenge there that is questionable is our per- sonal income ratios: our growth in taxes traditionally has been estimated at 1.2 percent or something like that, a ratio of 1.2 percent. Now we are seeing 1.8 to 1.9 percent, and so is the United States, and I have talked to the Secretary of the Treasury there about this. The explanations are sort of ques- tionable; it may be that we are underestimating the size of the economy, and that is one of the theories. It may be just a lot of wealthier higher- income earners are earning a lot more.

PO: But you have seen Harry Potter’s mailbox with the envelopes flying in ”” it seems like the cash is kind of flying through your mailbox. Is it that the corporate tax receipts are up, the GST receipts are up despite the cut, or personal receipts are up, or oil royalties, or all of the above?

JIM FLAHERTY: All personal and corporate taxes are up, and GST rev- enue as well. We reduced the GST by a full percentage point, but taking that into account GST revenues are up as well. And our spending: we aren’t just spending, and that is just being a Tory government. The Treasury Board under this government is pretty tough, it is hard to get money out the door, so we have some significant billions of dollars of underspending in the past fiscal year, and it looks like a perma- nent feature. So I take that into account, too, when I budget, and my department gets concerned when we budget close to the line, but I look at past experience and I am comfortable with where we are with the aspect of under spending. We will see. If this pattern on the personal income tax side continues, we are going to have to adjust more. We did an adjustment this year on the ratio to be less conservative, but we will have to do more if that persists.

PO: The item enabling parents to establish trusts for the parents of disabled children, or children with special needs, to establish trusts for those children to look after them over the years, does that come from your personal experience somewhat as a parent of triplets, one of whom has special needs?

JIM FLAHERTY: It does. It is a strange thing in life. I got involved when I was in the Head Injury Association in Durham Region, many years ago I was on the board, and I became president. I was asked to do it as a community endeavour. And I ended up as a lawyer acting for quite a few brain-damaged children ”” from trauma, usually, some of them were medical cases, but mainly from trau- ma. So that made a difference, and I actually have had quite a bit of experi- ence dealing with families who go through that kind of burden. So it was something I wanted to do and in the budget last year we provided for a panel to study it, which they did, and they reported back, and I am very happy that it is in the budget, it is very important. And it is moderately expensive but it will do a great deal of good, and there is more to be done. But that is one thing from a federal tax policy we could sort of do, and I do have per- sonal experience with it as well.

PO: You know, when you were at the end of your days at Queen’s Park, you were seen as kind of a dour denizen of that place, and someone who had lost the leadership twice, and here you are in Ottawa kind of transformed into the happy warrior of Parliament Hill. How do you feel about being here as opposed to Queen’s Park in Opposition?

JIM FLAHERTY: I am very lucky, and I think back to a lunch I had with the Prime Minister, the now Prime Minister, I guess it was a couple of years ago now, where I called him actually to talk to him about the state of the federal party. I was concerned about it. And I ended up leaving the lunch, thinking seriously about running as a federal candidate and resigning my provincial seat, which was a significant risk but I have taken a fair number of risks in politics, and it is a risky venture anyway. If I wanted not to take risks, I could continue practising law. I would be better off financially but I sure wouldn’t have had the opportunities I have had politically. Yes, so I resigned my seat when the election was called; there was a Liberal incumbent in my riding who had been elected three times, I think, so it was not a given that I could win. So that was a challenge, and I was thrilled when the Prime Minister offered me the job as minister of finance, and also I am thrilled with the scope he has given me. We have a very good working relationship, and you know, many people that have been around Ottawa for a long time have told me it is vital for a government that a prime minister and a minister of finance work well together. We do, and I respect his views, and he respects mine, we don’t always agree on everything, but he can be convinced, and I can be convinced. So it is a very good relationship. Just the scope of what we have been able to do in two budgets, I really am very thrilled with it.

PO: Do you agree that a finance minister has one thing to do all year, and that is to get his budget right?

JIM FLAHERTY: Yes, that’s what the Prime Minister and others said to me last year: ”œWe have to do a budget right away, we have just been elected, you will be very busy, but after that you will have more time.” But after that we had to do the economic plan because we didn’t have one, and one of the criti- cisms which had some merit last year was where is this budget going. You know, ”œYou don’t have a plan.” So we worked hard on that and created an economic plan, which gives us a frame- work, a prism through which we can gauge the validity of ideas, how they fit, or don’t fit, and then the income trusts issue came along.

PO: I was going to ask you about that. That struck me as a very professional job, but that also you knew you were going to take a hit on integrity.

JIM FLAHERTY: Yes, all of the above. And, you know, I resisted deal- ing with it, because I really did not want to get into that issue. There had been a commitment made, and the situation was deteriorating badly, but I talked to a lot of CEOs and members of boards, and I kept hearing the same thing, even from some of the more altruistic people in business, who told me even against the self-interests of their own enterprises, ”œJim, you had better do something about it, this is not good.”

PO: Was there a tipping point there, Telus and Bell announcing they were converting, or the rumours about Encana converting to an income trust?

JIM FLAHERTY: All of those. And the numbers were increasing, and then the nature was changing, so that was a good test of my relationship with the Prime Minister actually, because I was the bearer of bad news to him in terms of my recommendations to him, and we did it and it was the right public policy, and we survived.

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