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Ottawa and the provinces, most notably Ontario, must lay out credible plans to heal their finances in coming years when they release their upcoming budgets or risk damaging the economic recovery, suggests former central bank head David Dodge.

His ideas include boosting government revenue by increasing the GST, creating a carbon tax, or instituting user fees for services such as roads.

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Ottawa released its latest fiscal update yesterday, showing it racked up a $31.9-billion deficit between April and October, compared to $100-million in the same period a year ago. Revenues fell $16.1-billion as personal and corporate income taxes dropped by 7.4 per cent and 36.9 per cent respectively.

A credible plan to close the fiscal gap should include new sources of revenue, putting policy makers in a tough position because tax increases are sure to be unpopular, Mr. Dodge suggested in an interview yesterday.

"Nevertheless, government has a responsibility to put itself in a position where it is fiscally sound and not in hock to its bankers and where its actions are not responsible for driving up longer-term borrowing costs that will hamper the ability of the country to make investments in productivity," he said. "Taxes are going to end up going up one way or another."

But he made it clear that he would only be in favour of increases that are unlikely to damage productivity growth at a time when the size of the labour force is stagnating.

He argued that much of the problem federally could be dealt with by restoring the GST back to its 7 per cent level, which would bring in enough revenue that Ottawa could feasibly - although not easily - cut spending and balance the books without touching transfers to the provinces or individuals. The Conservatives have reduced the GST twice, from 7 per cent to 6 per cent in 2006 and then to 5 per cent in 2008.

"This is not as difficult a task as what we faced in the early '90s," Mr. Dodge said, but added, "I think it is unfortunate when politicians of any stripe lead us to believe that we'll be able to do the fiscal correction painlessly. That's not the case."

Ottawa has said it doesn't plan to use tax hikes or cuts in transfers to individuals or provinces to balance its books, but will look to reduce the 3.3-per-cent annual growth in the $100-billion it spends each year on federal programs.

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Other ideas for raising revenue could include specific consumption taxes, or taxes related to carbon that would create a new incentive to decrease greenhouse gas emissions, Mr. Dodge said.

"Finally, we really do need to start to have people pay for the individual services they use, whether that be roads or postsecondary education or whatever," he added. "I don't think we should have the horror of user fees that we seem to have."

Finance Minister Jim Flaherty said yesterday that total transfers to provinces and territories will increase by $2.4-billion this year, bringing federal support for those governments to its highest level ever.

Mr. Dodge estimates that, together, the provinces and Ottawa over the next decade will be dealing with a fiscal gap equivalent to about 3 per cent of GDP that will have to be closed, an estimate that's higher than many.

Were it not for extraordinary revenues resulting from high resource prices and the capital gains tax, it's likely that Ottawa was running a structural deficit heading into the financial crisis, he said. Not only the federal government but Ontario, in particular, will have to experience significant fiscal retrenchment.

"Budget season is coming up," he said. "If we don't see a plan laid out, I think there is a risk that markets will begin to lose confidence in what's going on."

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Ontario Finance Minister Dwight Duncan said in October that running a deficit to preserve and create jobs and establish a stronger economy after the recession is the right thing to do in tough times, but the province will outline its plan to restore fiscal balance in its 2010 budget.

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