BUDGET 2012: THE NUMBERS JUST DON'T ADD UP
This paper looks at the economic and fiscal projections presented in Budget 2012. Based on our assessment of the proposed expenditure “savings”, we believe that the Government will not balance the budget in 2015-16, and may have difficulty in achieving a balanced budget by 2016-17. The fiscal impact of some the expenditure savings are overstated and unless programs and services are cut, it will not be able to achieve the targeted savings through “efficiency” measures.
Budget 2012 continues to use the average of the private sector economic forecasts for budget planning purposes. There is no discussion in the budget on the range of the private sector views, so it is difficult to assess the risks inherent in this “average” forecast.
We continue to argue that the Minister of Finance should use the Department of Finance’s economic forecast instead of the average private sector forecast. The latter is not a “consensus” forecast but simply an average of those economists surveyed. Furthermore, few of these forecasters provide medium-term forecasts, thereby questioning the credibility of the five-year forecast.
The Department of Finance allocates the main private sector economic aggregates into its various components. It is these components that are used in forecasting federal revenues and expenses. Considerable professional judgement is applied in this allocation. We, along with others, have argued that these components should be published in the budget in order that a proper assessment of the economic forecast can be made. As in the past, no details were provided in Budget 2012.
It is time that the Government took full responsibility for its economic forecast, instead of hiding behind the private sector. The Ernst and Young study in 1994 never recommended that the private sector average be used. Instead, it recommended that private sector economists only be consulted.
The “Adjustment for Risk” (Prudence)
There are a number of downside risks to the economic forecast that are discussed in the budget. As a result, the average of the private sector economists’ forecasts for nominal GDP has been adjusted downwards by $20 billion per year. In the November 2011 Update, the “adjustment for risk” was $20 billion in year 1, $30 billion in year 2, $20 billion in year 3 and $10 billion per year thereafter. The profile, therefore, is somewhat lower in year 2 but higher in the outer years, perhaps recognizing the fact that risks increase over time, not diminish.
We applaud the inclusion of the “adjustment for risk” in the economic and fiscal forecasts. This recognizes that forecasting is not an exact science. However, we believe that risks increase over time, and the adjustment for risk should reflect this. From $20 billion in year 1, it should increase by an incremental $10 billion per year reflecting long-term uncertainty.
The adjustment for economic risks translates into a fiscal impact of $3.0 billion per year. Increasing the economic risk over time, as recommended above, would increase the fiscal impact from $3.0 billion in 2012-13, to $4.5 billion in 2013-14, $6 billion in 2014-15, $7.5 billion in 2015-16, and $9.0 billion in 2016-17. Such a profile would delay the elimination of the deficit to 2016-17, unless the adjustment for risk is not required. A constant adjustment for risk over the planning period does put in question the achievability and credibility of the deficit forecast.
The “adjustment for risk” continues to be allocated among the various revenue components. This makes it impossible to assess the credibility of the individual revenue components to current financial developments. To improve transparency, we continue to recommend that the adjustment for risk be shown separately.
Planned Departmental Savings
The planned Departmental savings in Budget 2012 consist of two major components – “reductions in departmental spending” and “updating defence capital funding”. Little detail is provided on how these savings are to be achieved. In attempting to assess the impact of these cuts, a number of other questions arise, which seriously undermines their credibility.
First, one of the largest savings comes from “Updating defence capital funding”. This is being done to “ensure that funding for major capital equipment procurements is available when it is needed. The Government is adjusting the National Defence funding profile to move $3.54 billion over seven years into the future period in which purchases will be made” .
The "savings" of $3.54 billion included in Table 6.3 are on a cash basis of accounting. However, sthe Budget projections are all on an accrual basis of accounting. Capital acquisitions are amortized over the economic life of the acquisition. Under accrual accounting, the impact of a capital acquisition is spread out over a long time period. As a result, the deficit projections are likely to be understated by about $0.4 billion in 2012-13, $0.5 billion in 2013-14, $1.3 billion in 2014-15, $0.7 billion in 2015-16, and $0.3 billion in 2015-16. This is verified by comparing the “capital amortization” projections in Budget 2012 (Table 6.6) to those in the November 2011 Update, with the Budget projections being higher rather than lower.
Second, the Government claims that most of the savings will be achieved through efficiency measures and not through cuts to programs or services. Yet, the forecast for “other transfer payments” has been revised down significantly since the November 2011 Update, by $2.4 billion in 2012-13, $1.1 billion in 2013-14, $0.2 billion in 2014-15, $0.5 billion in 2015-16 and $0.7 billion in 2016-17.
By 2016-17, it is at the same level as in 2008-09. There is no explanation for these downward adjustments. The extent of the decline is surprising given the nature of the components in this category – transfers to First Nations for education, health, social assistance, agricultural subsidies, student assistance, transfers to granting councils, among others. In addition, most of the new spending initiatives announced in Budget 2012 will be included in this category of spending.
Third, departments are appropriated funds by Parliament. They cannot exceed those limits. As a result, they engage in prudent planning, ensuring that their spending limits are not exceeded. This results in departments lapsing funds (not spending all of their appropriations) at year end. In setting the expense projections, the Department of Finance normally takes this into account and includes an estimate of this lapse, based on previous years’ experience and other factors.
However, the various expenditure reduction exercises over recent years, without major cuts to programs and services, have forced departments to operate “closer to the edge”, implying that the lapse at the end of the year will be lower than in previous years. In examining the program expense projections, it does not appear that the Department of Finance has taken this into account, thereby overstating the net impact of the expenditure reductions. No projections of the lapse are provided in the budget documents. Nor is there reconciliation between the Main Estimates and the expense projections in the Budget Plan . This has not been provided since Budget 2007.
Finally, we, among others, have always questioned the profile of “direct program expenses” (total program expenses less major transfers to persons and other levels of government), claiming that the outer years projections were understated. Prior to Budget 2012 initiatives, direct program expenses were forecast to grow at annual average rate of about 2.5% between 2008-09 and 2016-17, an extremely ambitious target.
If we are right, then the credibility of the fiscal projections is seriously undermined. With the exception of 2011-12, the deficit projections appear to be understated and the surplus projections overstated. Unless there are cuts to programs and services, or stronger economic growth, it is unlikely that the deficit will be eliminated by 2015-16 or even 2016-17.