Construction Industry Forecasts

Yesterday’s Ontario provincial budget contained measures to stimulate business investment, to lower corporate taxes and to reduce sales-tax administration charges. But the major initiative was in the area of infrastructure spending. This has been a consistent theme of governments around the world. Who knows if all this money will ever really be spent? To a considerable degree, Premier McGuinty, Prime Minister Stephen Harper and President Barack Obama are all trying to do the same thing, talk us out of this recession.

The means by which the United States and Canada escaped from the Great Depression was a necessary public spending binge in order to fight in the Second World War. To put things into similar martial terms, think of the present-day fiscal-deficit responses in these comparatively peaceful times as mobilizations on the infrastructure front.

The Good and the Bad of Massive Public Works Projects

Massive public spending on infrastructure will be good if it fixes deteriorating physical assets, elevates human capital through educational opportunities and helps industrial output and foreign trade longer term. It will be bad if the spending gets sidetracked into “earmarked” projects (in the American lexicon) or “pork-barrel” projects (understandable in anyone’s language). The same negative connotation applies to “make work” projects.

The move to combine the provincial sales tax (PST) and the Goods and Services Tax (GST) in one harmonized or value-added tax, likely to be referred to as the HST, is an excellent idea. It lowers the charges for equipment purchases for businesses, due to the flow-through or rebated component, and it reduces administration headaches and costs.

Questionable Aspects of the HST in Residential Markets

However, there are some questionable aspects of the HST with respect to residential construction. There will be exemptions or partial rebates of the provincial portion of the HST on new home purchases up to $500,000. While Premier McGuinty is providing stimulus to non-residential construction, he is taking it away on the residential side.

The HST will not likely have much impact on the plans of first-time homebuyers who are taking advantage of super-low mortgage rates to purchase lower cost housing. Where the real estate market is currently suffering is in the higher-priced homes category and this is unlikely to recover by July 1st of next year, when the HST comes into effect.

Due to the shortage of land, and with the exceptions of some tear-down-and-replace and fill-in projects, the half-a-million-dollars-and-up homes market in a city like Toronto is squarely based on condo sales. This segment is already being hammered by the recession.

The HST will be one additional factor driving down condo sales, unless one assumes that rich people and especially well-heeled foreigners have no qualms about paying what amounts to the cost of a luxury car in additional taxes. The revenue from this measure hardly seems worth the effort, until the market improves. The opposition parties should be arguing for a temporary delay in implementation in this special instance.

The HST will Promote Shorter-term Mortgages

There is one further consideration. In most cases, the increased tax on new home purchases will presumably be paid by upping mortgage principal amounts. Given the difference in mortgage rates between one- to two-year terms (about 3%) and five years “fixed” (about 5%), the HST will promote the adoption of the shorter-term option in order to reduce monthly payments.

Is this what the government really wants? Experience with adjustable rate mortgages south of the border and what can happen once inflation and interest rates start to climb again has demonstrated that unfortunate consequences can be the result.

Alex Carrick